Optimizing Structures for Business Aircraft Ownership and Operations
Owning and operating business aircraft typically involves a large initial investment and annual budget. The ownership structure can have significant tax implications, affect liability exposure and raise regulatory compliance issues. There is no one-size-fits-all solution. Rather, the structure should be tailored to each company’s particular usage and tax profile.
Many owners and operators are concerned primarily with minimizing liability exposure, tax planning objectives, regulatory compliance, and, in some cases, ways to offset costs. It is advisable that they also develop plain-English corporate usage policies and avoid overly complex structures that are difficult to implement and adhere to in practice.
Compliance with Federal Aviation Regulations
The Federal Aviation Administration (FAA) imposes more stringent requirements on air-carriers (i.e., FAA certificated commercial airlines and air-charter operators) than it does on operators of private aircraft. Generally speaking, only an air-carrier can charge for carrying passengers or cargo. When a private aircraft owner/operator provides its aircraft with crew to another person or entity for compensation, it is essentially providing a complete transportation service and, except in limited circumstances, cannot be compensated directly or indirectly for that service.
The FAA allows private operators of large aircraft to recover costs for aircraft operations from other parties in a few limited circumstances set forth in Federal Aviation Regulations (FAR). The two most common forms are as follows:
- Intra-company Reimbursement. In general, a private company that operates an aircraft incidental to its primary business can charge other companies within the wholly-owned family of parent/subsidiary relationships without any specific lease or documentation.
- Timesharing Agreement. Where an officer or employee wants to use a company aircraft for personal use (or the company wants to let an unrelated company use the aircraft), this can be accomplished under a “time sharing agreement” type of lease in which remuneration is limited basically to direct operating costs.
We caution that the FAA has held that these cost-sharing provisions are available only for a company that has a primary business purpose other than providing air transportation. For this reason, a company whose sole or primary purpose is providing air transportation even to its parent company or sole shareholder would require an air-carrier certificate to receive any compensation directly or indirectly for such flights, even from its parent company or member. This means that “flight department” subsidiaries cannot generally be used for liability-protection purposes.
Limiting Liability Exposure
For businesses and individuals who own aircraft, limiting liability exposure is a significant concern. The following are several considerations:
- Insurance. The most important point is that owners/operators should verify that they have proper insurance coverage with adequate limits (it is not uncommon to have $250-$500 million in liability coverage). Owners/operators also should ensure that all relevant parties and types of operations are covered. For example, a charter-manager policy may list the owner as an “additional insured” which may or may not provide coverage to the owner for the owner’s own negligent operation of the aircraft.
- Corporate Structure. A company may be able to structure aircraft operations to occur through a minor subsidiary (subject to the flight-department company limitations discussed above) and/or place aircraft title in a holding company.
- Corporate Formalities. To take advantage of the protection from liability created by a corporation or limited liability company, it is important to follow corporate formalities. If these formalities are not followed, a plaintiff may be able to “pierce the corporate veil” and hold the principal liable. Corporate formalities include using separate bank accounts, registering entities to do business in the state where they operate, and avoiding use of the company assets for the personal business of individual members without proper documentation.
Proper federal and state tax planning generally requires input from both an aviation tax professional and a company’s in-house or regular accountants. Tax planning should address not only the initial acquisition of the aircraft, but long-term planning, so that the mechanisms for documenting costs and usage can be put in place. The following is an outline of the major tax considerations:
- Depreciation of Aircraft. Generally, aircraft used in a trade or business are depreciated using one of the following methods:
- A five-year Modified Accelerated Cost Recovery System (MACR) for aircraft used primarily in business other than air transportation (seven years if the aircraft is used primarily in air transportation (e.g., charter operations)). Accelerated depreciation may also be available for new aircraft.
- A six-year Alternative Depreciation System (ADS), which is a straight-line depreciation for aircraft used primarily in a business other than air transportation (12 years if the aircraft is used primarily in air transportation).
However, where the aircraft has significant personal or related-party use, the ability to depreciate the aircraft may be limited by the following:
- Under the “Hobby Loss Rule,” for individuals and flow-through entities, certain deductions (including depreciation) are limited when an activity is not deemed “for profit.”
- Individuals and certain other taxpaying entities are restricted from applying the losses from passive activity to active gains (e.g., passive losses can be used only to offset passive gains).
- Accelerated depreciation under MACRs is available only if the aircraft is predominantly (at least 50 percent) used in a qualified business use in a trade or business for any taxable year.
- Certain non-business use (such as personal use by executives) and entertainment use by owners or by executives also impact depreciation calculations and deductibility of other aircraft-related costs.
- State Sales and Use Taxes. State laws regarding sales and use tax vary. Most states have sales taxes that apply to aircraft delivered/purchased in that state, subject to certain state specific exemptions. Many states also impose a “use” tax for aircraft, for aircraft that are principally based/used in that state. In addition, some states have property taxes and/or registration fees.
- 1031 Tax-Free Exchanges. If selling a fully depreciated aircraft, the company may have a significant depreciation recapture gain. A company may be able to defer both ordinary income and capital gains by engaging in like-kind exchange under Section 1031 of the Internal Revenue Code (IRC). With the use of a financial institution as a “qualified intermediary,” the acquisition of the new aircraft need not be simultaneous with the sale of the old aircraft but must take place within 180 days and meet other notice requirements.
- Personal and Entertainment Use. Personal and entertainment use of corporate aircraft can affect depreciation and the deductibility of operating costs associated with those flights, implicate SEC reporting, and/or create imputed income to the employee.
- Federal Excise Taxes. Essentially there are two elements of federal tax: a per-gallon transportation tax and a fuel tax. Air carriers are required to collect a transportation tax equal to 7.5 percent of the compensation for carriage, plus a per flight segment, per passenger fee. Private operations do not incur this tax, but the IRS considers some types of private flights, including time-sharing arrangements, as being air transportation subject to the transportation tax. Both private operators and air-carriers pay fuel taxes, but the fuel tax on fuel used for private operations is higher than for commercial operations.
- Keep Structures Simple and Functional. Where structures are complex or the “paper” structure is not logical, the original legal structure is often ignored or misapplied. Particularly within closely held companies, it is all too common to ignore corporate formalities, which could potentially allow a plaintiff to “pierce the corporate veil” and hold a principal or parent company liable. Similarly, where the structure requires inter-company payments between related companies, failure to make such payments or keep accurate records could negate tax-planning objectives.
- Corporate Aircraft Usage Policies. Adoption of a plain-English corporate aircraft usage policy that can be used by operational staff is advisable. Such a policy can ensure that flights are made consistent with approved policy, and provide a mechanism for collection of flight information for tax or reporting purposes.
- Reporting Requirements for Companies. Publicly-traded companies are subject to Securities and Exchange Commission reporting requirements for perquisites involving personal use of corporate aircraft by directors and certain officers. Companies participating in various federal relief programs may also be subject to certain publication and/or reporting requirements.
- Using Charter-Management Companies. Many companies turn to charter-managers to either provide turn-key management or more limited services to the company. There is a wide range of aircraft charter-managers that can provide flight crew, insurance, logistics, maintenance, etc. FAA-certificated charter-managers can charter a company’s aircraft to third parties to generate income for the company and allows flexibility in charging related parties for use of the company’s aircraft.
In conclusion, determining the best structure for a company’s aircraft operations requires consideration of FAA regulations, liability exposure, tax consequences and other factors.