Just days before Christmas, my client, a young CEO of a hugely successful financial services business called me with exciting news: he decided to buy a plane. In fact, he was trying to close on the purchase by New Year’s Day, as he put it, “you know, to get the tax benefits”. After congratulating him on his pending purchase, and asking a few questions about the proposed transaction, I delivered a message that would change his holiday plans: there were no tax benefits – and if we don’t restructure this deal – he will be writing a huge tax check just in time for the holidays. Fortunately, the story did end well, the deal closed in January, no tax bill was due, and the plane was ready to fly to New Orleans for Super Bowl XLVII.
I have received similar calls, and delivered a similarly cautionary message a few times each year to clients. The reality is that tax issues persist in the private jet space. Whether the proposed acquisition or sale is a fractional interest through a NetJets purchase program, or a custom Gulfstream G550, the issues must be addressed in order to avoid a surprise tax bill. In practice, we run into a number of tax issues consistently: state sales and use tax, utilizing active/passive losses, business vs. personal use, and federal excise taxes. Below, I address a few of these topics briefly so that the readers of Chief Executive will not fall into the same traps that have caused my own clients so much aggravation and, sometimes, an unexpected tax liability.
State Tax Issues
The most prevalent issues in aircraft taxation relate to the imposition of state sales and use taxes. The general rule in most states is that the sale of tangible personal property will be subject to sales tax (usually 5-10% of the purchase price). Likewise, if a sale was not subject to sales tax in the state that the plane was sold, the state that the plane is flown to for its use will impose “use tax”. Moreover, each state has its own set of rules in defining what constitutes a taxable sale or use.
Various states have limited exceptions, for example, that sales tax is not imposed on sales when the plane will be used in “interstate commerce” or if the plane is held for “resale”. Other states have “fly-away exemptions” allowing planes sold in a state to avoid sales tax if it is immediately flown to its home state. Indeed, in the young CEO’s transaction above, moving the closing of that transaction from Nevada to Arizona (for a plane that would be stored on the east coast), saved more than $225,000!
A similar issue sometimes arises when a plane is sold in a state other than the owner’s resident state. Depending on applicable law, a state may take the position that the sale should be subject to state tax where the closing takes place, rather than the state in which the property was used (since, unlike most property – airplanes easily move from state to state). This issue can be easily avoided – so long as the sale has not already taken place.
Active vs. Passive Losses
Plane ownership frequently results in losses for tax purposes. This is due to a number of factors: high costs of maintenance, fuel, and pilots, accelerated depreciation and inconsistent usage. However, the ability to take losses relating to the lease of tangible personal property is not assured, even with a strong fact pattern. Accordingly, much of our work involves navigating through the passive loss rules to allow client to take a defensible position to treat losses as active losses (which often runs contrary to advice from any attorney concerned with personal or corporate liability). Other issues arise in using passive losses upon disposition of an airplane, if the new plane will be purchased to engage in the same activity.
Business vs. Personal Use
Whether the use of an airplane is a business or personal expense is a particular favorite of the IRS. This common audit issue requires substantial compliance by the taxpayer in keeping appropriate logs, evidencing business purpose of each trip and avoiding intermingling business and personal affairs.
Federal Excise Taxes
The IRS is currently aggressively imposing excise tax for any chartering/leasing arrangement that may impact existing leasing arrangements (as well as new transactions) based on recently issued guidance. With a tax rate of 7.5% of the transportation or fuel costs, careful planning is required to mitigate tax liability.
Every CEO I have ever represented cares very deeply about two things: not paying more taxes than required and avoiding unnecessary aggravation. Careful planning for airplane transactions will allow both of these goals to be accomplished.
David Rosen (email@example.com) is a CPA and tax attorney for Rosen, Sapperstein & Friedlander. RS&F is a business consulting and accounting firm based in Owings Mills, MD that serves middle market and high-net worth individuals throughout the mid-Atlantic and across the country.