The Complexities Associated with the Purchase of a Corporate Aircraft
In response to your request for our input on the purchase or use of a corporate jet our opinion follows.
The purchase of an aircraft is perhaps the most complex transaction that business owners can undertake. Unlike any other asset, not only do the ownership, use, and location options need to consider the legal and tax ramifications, but also the rules, restrictions, and implications of the Federal Aviation Administration (FAA). This is NOT simply a matter of what type of entity should own the aircraft and in which state should that entity be established. The manner in which the aircraft is funded, owned, and operated can determine which FAA regulations apply – Commercial Aviation Rules versus General Aviation Rules.
The main issue with private corporate ownership is that if you fall under the commercial aviation rules you are treated just like United, Delta, and American and can be subject to six and seven figure fines that may be assessed retroactively on a per flight basis. The complexities associated with corporate aircraft ownership has created attorneys know as aviation attorneys that dedicate their legal practices to these issues.
The Complexities of the Governing Rules – FARs
The complex FAA rules know as Federal Aviation Regulations (FARs) must be analyzed carefully when purchasing and operating an aircraft. Particularly, FARs Part 91 regulates General Aviation Rules that apply to business and personal use of aircraft and are generally much less restrictive than those found in FARs Part 135 – Commercial Aviation Rules, which apply to aircraft used commercially but also those classified as used “for hire.”
So on the surface at least it would seem that to avoid the complexities and cost of complying with the Commercial Aviation Rules, the ownership and operational structure should be set up to avoid the “for hire” usage. Sounds simple, but the IRS regulations complicate and seem to be at odds with this strategy.
The FARs and IRS Code Sections 61 and 274 create a tangled and at times conflicting set of rules for a business that wants to limit liability and minimize taxes. To avoid or limit income restrictions and adverse tax consequences including the disallowance of operating deductions, the IRS has advised businesses to have their owners and employees reimburse the company for the value of the aircrafts use on non-business flights. Although this alleviates tax issues, it unfortunately puts the business in the “for hire” provisions (even if done at cost, a lack of profit doesn’t matter) and therefore classification as a commercial carrier.
Other tax considerations that are beyond the scope of this initial analysis include sales and use tax on the purchase and use of the aircraft, depreciation rules that vary by the use of the aircraft, and Section 1031 rules that provide a tax friendly way to “trade-up” to your next aircraft. Note: Sales tax rules apply generally based on where you accept delivery of the aircraft. Use taxes still would apply in other states. Sales tax issues should be considered before the purchase of the aircraft.
The FARs also creates potential issues regarding insurance. Given the complexities of the rules, insurance coverage that was purchased as a non-commercial operation that unwittingly operates under FAA commercial status could be flying the plane without insurance for the plane, passengers, or crew. This could result in potentially large legal liability issues to the business entity and owners. A careful examination of insurance coverage and usage is critical.
The Single Asset Issue – This is Important
Under the FARs, an entity whose only asset is an aircraft is deemed to be in the business of providing air transportation service for compensation, and as such, must operate under the stricter commercial standards of Part 135. Undoubtedly, the FARs create complexities unlike the more traditional tax and legal asset planning strategies.
So now that you better understand the complexities, here are a few of the options for ownership:
Ownership Option 1 – Exclusive Ownership
A new LLC is formed “JetCo” to purchase and own the aircraft. However, to avoid the Commercial Aviation Rules, JetCo should not operate the aircraft. Instead JetCo should “dry lease” the aircraft to the current business entity. A “dry lease” is the lease of an airplane without a captain and crew. The current business entity, the lessee, provides the captain and crew. This structure should allow you to operate under the more desirable General Aviation Rules but care must be taken to ensure that the lease payments do not exceed the permissible amounts. It may also be prudent to carry additional liability insurance to cover operator negligence or error, given that the business entity provides the captain and crew. The company must employ the pilot and crew as employees or independent contractors. This should be explored in greater detail. The single asset issue must also be considered.
And of course, complexities are also created with any guest passengers.
Ownership Option 2 – Purchase and Enrollment in a Charter Service
A new LLC is formed “JetCo” to purchase and own the aircraft. However, the aircraft is then enrolled in a charter service. Under this arrangement, JetCo owns and “dry leases” the aircraft to the current business entity as well as the commercial charter service. The charter service uses the aircraft to transport third parties. This option helps to defray ownership costs, but the aircraft will not be available 24/7 and may not be available for last minute or unplanned trips.
FAA Regulations that pertain to charter services must also be analyzed and considered before committing to this option.
Option 3 – Fractional Ownership
FAA Rules permit multiple individuals or entities to jointly own a corporate aircraft. Fractional ownership is essentially equivalent to an “aircraft timeshare.” This option is generally less complex and less expensive than exclusive ownership. The fractional sponsor generally deals with regulatory compliance, aircraft management and scheduling, and liability insurance.
Option 4 – Jet Cards or Air Taxis
A company can pay a fee in advance and have the ability to fly a set number of hours per year. Jet card programs do not provide ownership benefits, but do avoid the complexities and capital investments of private ownership.
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The forgoing should not be construed as legal advice, and should merely be used for preliminary discussions. You should consult with an aviation attorney before taking any action.
CIRCULAR 230 DISCLOSURE: In compliance with the requirements imposed by the IRS pursuant to Circular 230, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.