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Airplanes and Taxes

Published on October 1, 2012, in Aviation.

Interest rates for aircraft loans will only increase from present level.  Taxes will only go up.  Airplane loans are available now at 5% interest, fixed for twenty years.  Substantial income tax reductions and low interest rates afford business an opportunity now to get started in aviation to achieve growth that’s unattainable without the benefit of owning aircraft.

 

After the events of 9-11, the “Jobs and Growth Tax Relief Act” offered a 30% write-off for the purchase of new business equipment, including aircraft.  The write-off was increased to 50%, then 100%.  Since then, “bonus depreciation” expired and was renewed.  Until the present rule expires this December 31, 2012,  a new aircraft buyer can write off a combined total of 70 to 100% of new aircraft cost in one lump sum.  This reduction of tax burden outweighs ownership cost in initial years, it allows an owner time to fully integrate the aircraft for maximum benefit.  The owner may need to learn to fly!


Taxes, You Owe


Aircraft are taxed whether for personal or business use like anything one buys.  Aircraft may be subject to sales tax, use tax, personal property tax, and registration and licensing fees according to the laws of the state in which it’s owned or used.

 

State Sales Tax

 

State sales tax is the tax paid to the state upon retail purchase.  To avoid paying sales tax, thousands of aircraft owners legally register aircraft in states that do not have sales tax and attempt to “fly under the radar” in their home state by suppressing their aircraft tail number from online flight tracking.

 

States with no sales tax are: Alaska, Delaware, Massachusetts, Montana, New Hampshire, North Carolina, Oregon, and South Carolina.

The FAA allows aircraft to be registered wherever an owner maintains a valid address, so thousands of aircraft are registered to the address: 3511 Silverside Road, Wilmington, Delaware.  That’s the address one of several companies that specializes in registration and mail forwarding for aircraft and yacht owners.

 

 

Aircraft sales tax may or may not be collected by the seller, an aircraft dealer or an individual.  Most states will instead send buyers notice of tax due once the plane is registered and the state learns of it from the FAA.  States and local tax authorities search information for ownership and where aircraft are kept from public-owned airports and from air traffic control data that’s available online.

 

States with sales and/or use tax.  Source: Advocate Consulting Legal Group, PLLC

 

Use Tax

 

States may charge use tax in lieu of sales tax when an aircraft is operated in a state for periods of time.  Owners may not be up on state law, and may be caught by surprise by an unexpected use tax bill.  States (especially Illinois) are known to use tracking services like Flight Aware to discover aircraft that land at their airports frequently and are subject to their tax.  Such aircraft appear to be principally used in the state.  The rate is about the same as it is for sales tax.  In some cases, aircraft owners owe apportioned tax between multiple states based on company flight records.  A savvy taxpayer may keep an aircraft tax logbook to take advantage of lower tax rates.

 

Sales Tax Exemptions

 

Some states offer exceptions for aircraft being held for resale or that are for special use.  Exemptions for crop dusters and flight school aircraft are common.  Many states also exempt sales tax for dealers and planes that are rented, leased – even if the rental is to the owner’s own company.  In this case, the owner must pay sales tax on revenues from rental instead of being taxed on the aircraft purchase price.  An owner must make such election at the time of purchase before placing the aircraft into service.

 

 

States with occasional or casual sale exemption.  Source: Advocate Consulting Legal Group, PLLC

 

More than a dozen states exempt sales tax on occasional or casual sales.  A casual sale is an isolated sale made by an individual who is not in the regular business of selling aircraft.  It’s necessary to understand a state’s specific exemption and to record details of a casual sale.  Aircraft buyers will use an aircraft purchase agreement to document exemption eligibility.

 

Personal Property Tax

 

Like property tax on real estate, many states charge property tax on airplanes.  Local tax authorities (the county) assess aircraft value.  Airplanes are generally assessed at a rate of 30% of appraised “bluebook” value.

 

Aircraft Bluebook Digest or VREF wholesale value is used by most every tax assessor.  Fortunately this valuation is significantly less than market value.  Wholesale value times an assessment rate, often 30%, becomes the assessed value that is subject to tax at a rate called the mill levy.  The mill levy in suburban Kansas City is 113.5. Tax is figured like this:

 

Assessed Value = Appraised Value times Assessment Rate
Property Tax = Assessed Value times Mill Levy divided by 1000

 

A 2011 Cessna Turbo Stationair, for example, has wholesale value (according to Bluebook) of $468,000.  Appraised value times the assessment rate of 30% equals $140,400.  The assessed value, of $140,400, is subject to personal property tax in Johnson County that totals $15,935.40 for the year.  Many Stationair owners in Kansas opt instead to claim a business exemption.

 

Many stated invoice owners for property tax on aircraft that are physically located in the state on January 1st.  One half of the tax is due by December 20th, the second half is due May 20th, the next year.


States with sales and/or use tax.  Source: Advocate Consulting Legal Group, PLLC

 

Kansas exempts property tax for aircraft that are used for business and also exempts antique aircraft that are at least thirty years old.  Missouri allows property tax on business aircraft to be apportioned between states based on the percent of hours actually flown in Missouri airspace.  Owners must acquire exemption status from the tax assessor at or before the time of acquisition, not after getting a tax bill.  Owners should report aircraft hours, engine time, and other conditions that may reduce assessed value and lower the amount of tax owed.

 

Registration Fees

 

All aircraft are registered with the FAA.  The FAA maintains the “official title” or record of ownership and records liens.  Some states have their own state registration requirements with related fees that are normally collected with a state sales tax return.


Tax Deductions, You Save


Aircraft are a tax-favored investment, meaning the IRS allows individuals and companies to write-off depreciation and other expenses to recover the cost of assets consumed in business.  This is allowed for aircraft even though tax deprecation of aircraft far exceeds an aircraft’s actual loss of market value.  Aircraft may be fully depreciated for tax purposes over five years even though the economic life and value of the plane may be for several decades.


The tax deductions for which a business may qualify includes aircraft operating expenses, interest, and depreciation.  Taxpayers are additionally sheltered from tax liability on traded-in or replaced aircraft.  Within the rules of like-kind exchange, the remaining tax basis of a replaced plane is added to the cash difference to acquire a new replacement aircraft.

 

Section 179 Deduction

 

Before regular depreciation is taken, small businesses are allowed a Section 179 expensing deduction.  This deduction is for the full cost of the aircraft whether new or used, up to $139,000.  The deduction is targeted toward small business and is reduced dollar for dollar when a company’s total equipment purchases for one year exceed $500,000.

 

Bonus Depreciation

 

The “Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010” offered 100% bonus depreciation on new aircraft purchases until last year and still offers 50% bonus depreciation that will expire this December 31, 2012.  Bonus depreciation is allowed only on new aircraft acquired from a manufacturer or authorized dealer that is placed into service in 2012.

 

Recent History of Bonus Depreciation

Date Placed Into Service Bonus Depreciation Level
January 1, 2008 to September 8, 2010 50 percent
September 9, 2010 to December 31, 2011 100 percent
January 1, 2012 to December 31, 2012 50 percent
January 1, 2013 and on 0 percent

 

Regular Depreciation

 

Straight-line depreciation is the simplest method of depreciation whereby a taxpayer expenses the original cost of equipment in equal increments across five years.  Another, often preferred method, is accelerated or declining-balance depreciation, for example, the Modified Accelerated Cost Recovery System (MACRS).  The MACRS percent taken each year is: 20%, 32%, 19.2%, 11.52%, 11.52%, 5.76%.  Accumulated depreciation offers the greatest tax savings up front allowing a business lower cost until an asset is fully utilized.

 

Calculating the Deduction

 

Rules dictate how depreciation and bonus is calculated, e.g. rules set the order in which deductions are taken and how much first-year depreciation is allowed for mid-year purchase.  No matter when the aircraft is placed into service during the year, a maximum of one half year’s write-off is allowed, what’s called the half-year convention.  A mid-quarter convention limits first year depreciation for aircraft placed into service after September 15th to one forth.

 

The Order in Which Depreciation Deductions Are Allowed:

 

    1. Net Cost after Trade-In
2. Section 179 Expensing Election
3. Basis of Trade in Aircraft
4. Bonus Depreciation
5. Regular Depreciation

 

To use a new Turbo Skylane, for example, consider the total cost of the airplane, $443,500, less a traded in Skyhawk SP worth $125,000.  The trade difference or cash paid is $318,500 net price.  This is the starting basis of depreciation allowed on the new plane.  To calculate depreciation going forward, the Section 179 deduction of $179,000 must be taken first.  After the 179 deduction the remaining tax basis of a traded-in Skyhawk (for this example, $8,000) is added to the remaining ”book” value and becomes the adjusted basis of the new aircraft.  From the adjusted basis, 50% bonus depreciation may be taken, then the first-year MACRS depreciation.  In total, $251,200 deductions are allowed which amounts to 79% of the aircraft’s cost.

 

Taking Depreciation and Figuring Basis of the New Aircraft

 

$443,000

New 2012 Turbo Skylane

- $125,000

Trade-in 2003 Skyhawk SP

$318,000

Cash Paid

- $139,000

Section 179 Deduction

$8,000

Remaining Basis of the Traded Skyhawk is Added Back

$187,000

Adjusted Basis of New Aircraft*

- $93,500

50% Bonus Depreciation

-$18,700

Regular First-Year MACRS

$74,800

Basis of New Aircraft After $251,200 Total First-year Deductions

 

* The cost basis for depreciation may by further increased by the cost of commissions, sales tax, and other fees and expenses.  This will become the adjusted basis.

 

Taking the Tax Advantage

 

Tax deductions flow to an aircraft owner’s personal tax return and offset income on which he or she would otherwise be liable for tax.  Aircraft are normally owned by a Limited Liability Corporation, or LLC to take this advantage.  In an LLC, the profit or loss is reported on a K-1 form to its owners, called members.  Similar to receiving a W-2 or 1099 from an employer, an aircraft owner will include the profit or loss from the LLC on his or her 1040 income tax return.  A loss will subtract dollar for dollar taxable income. State income tax works the same way.

 

Example Tax Savings, First Year Ownership New 2012 Turbo Skylane with Synthetic Vision

 

$14,700

Revenue, Air Equipment Leasing, LLC

$327,628

First Year Depreciation from

$24,268

Operating Expenses

$19,392

Interest and Bank Fees

$371,289

Expenses, Air Equipment Leasing, LLC

- $356,589

Net Loss Reported to Owner on Air Equipment Leasing, LLC K-1 Form

$124,806

35% Federal Income Tax Savings

$21,395

6% State Income Tax Savings

$146,201

Total Income Tax Savings in the First Year

 

Total income tax savings during the first year of ownership more than affords a 15% down payment and all the acquisition and operating costs for a hundred hours of flying.  Total operating costs of a Cessna Turbo Skylane, including fixed and variable expense, typically runs about $240 per hour.

 

What would otherwise cost an owner or company more than seven hundred dollars round trip to operate a Turbo Skylane from St. Louis to Chicago and back - a year’s worth of such trips are afforded by tax savings alone.

 

Aircraft Leaseback

 

The term “aircraft leaseback”, loosely refers to a scenario where an aircraft owner leases his or her plane back to an aircraft dealer or FBO from which it was purchased.  Dealers rent aircraft for flight school use, sales demonstrations, and recreational purposes.  It’s a common scenario for an aircraft owner with limited or no business use to organize an equipment leasing business.  An aircraft leasing business is a normal and purposeful business use of aircraft.

 

Commercial insurance for aircraft rental is more expensive than keeping a plane solely for personal use.  Maintenance intervals are also more frequent and costly.  Yet, renting the aircraft affords a legitimate opportunity for an owner to take advantage of tax savings and rental revenue that is otherwise not available.


Now for the Gotchas!

Expenses associated with business aircraft are normally deductible for income tax purposes so long as the plane is used in an active trade or business and that the expenses are ordinary, necessary and reasonable.  In other words, an aircraft must be appropriate and helpful to a business and aircraft use must be typical to similar enterprises.

 

Personal use of aircraft

 

Full tax deductions for personal use may be allowed so long the purpose is not for “entertainment”, “amusement”, or “recreation”.  Personal use is treated as a taxable fringe benefit to an employee.  The value of personal use that’s allowed (attending funerals, visiting sick relatives, travel for medical treatment, commuting to work, or travel for private business activity or to manage personal investments) is reported to the IRS for income and employment tax purposes.

 

The value of personal to report is determined by an IRS formula called the Standard Industry Fare Level formula (SIFL).  It determines what a first-class seat on a comparable commercial flight would have cost and works by multiplying the SIFL cost per mile rate by an aircraft multiple based on aircraft weight and adding a terminal charge.  The SIFL method of figuring the personal use benefit is much less than what it would cost an employee or owner to reimburse actual operating cost of the aircraft.

 

Using SIFL, the taxable fringe benefit reported to the IRS for an employee to fly from St. Louis to Chicago on personal business for a company-owned Cessna Turbo Skylane would be $108.22 (258 statute miles times $.2455 per mile, plus $44.88 terminal charge). The employee will owe income tax on $108.22.  The company still writes off the full depreciation and operating expense for this flight.

 

The IRS does not allow taking depreciation and aircraft expenses for travel that’s for fun. Expenses for entertainment, amusement, and recreational flights are only deductible in the amounts fully reimbursed or reimbursed for the excess cost of the flight over what was reported to the IRS as taxable income to that owner or employee.  Travel for vacation, fishing, hunting, golf, weddings, birthday parties will proportionately reduce what a company may write off if not reimbursed.

 

IRS Scrutiny

 

Substantial income tax deductions in first year of ownership cause aircraft to fall under special scrutiny.  Documentation is essential to ensure entitlement to deductions in case of an audit.  A business plan should be adopted upon acquisition.  Records must be kept for the detail and purpose of all flights: business, personal, and recreational.

 

Hobby Loss

 

Depreciation may cause the entity that owns the aircraft to have a tax loss, especially when an aircraft is owned in a separate LLC holding company than by the business in which it supports.  IRS auditors have tried to disallow deduction of aircraft loss, based on “hobby loss” rules.  To avert this, businesses must show evidence the aircraft LLC is a “unified business enterprise” with the core business and is not subject to hobby loss rules.  Aircraft leasing companies must have a business plan that shows expectation of future profit in the business or demonstrate the purpose of the aircraft to the core business and that the costs are reasonable and necessary compared to alternative travel options.

 

Capital Gains

 

When an aircraft is sold for more than its book value (its undepreciated basis), the sales profit is a taxable gain, unless the the aircraft is traded “in like kind” for another plane of equal or greater value.   Under IRS section 1031 rules, capital gains tax is deferred.

 

Aircraft may be removed from business service and converted to personal use.  Unless the asset is sold, so long it has the same owner, there is no taxable gain.  Converting a business asset to personal use is not a taxable event, except that expense deductions end.

 

Passive vs. Active Income

 

The IRS will categorize an aircraft rental and leaseback business as passive or active.  Passive loss is only allowed to offset passive income and active loss is only allowed as a write-off against active income.  For example, passive loss is not allowed against income from a person’s regular job.  Passive activity is typically investments, like from owning real estate or rental properties – business activities in which the taxpayer does not “materially participate”.  Rental business where real or personal property is leased monthly or long term are automatically defined passive.  Hotel and movie rental business that have short term rentals are typically active type businesses.

 

An aircraft owner who needs active loss to write off against active income must be careful about how a lease relationship is structured with a flight school or aircraft operator.  For the business to be categorized active, the owner must materially participate in the leasing business at least 100 hours per year and more than any other individual.  The agreement with an FBO that rents the aircraft may take the form of a marketing and maintenance agreement and define specific services rendered whereby the aircraft entity is an “active” business enterprise.  Rentals must be for hourly or daily periods, not month to month.  If passive loss is desired, a longer term lease is appropriate.

 

Another strategy to avoid a passive category trap is to make an election called grouping.  If an aircraft is used to support a business in which the owner is actively engaged, he or she may elect to treat both businesses as a single undertaking whereby the combined business is categorized as active.

 

Double Taxation

 

Regular corporations are taxed at both the corporate and owner level.  A limited liability corporation or LLC is the choice method to incorporate because the tax treatment “flows through” to the owner.  An LLC’s income is taxed only at the owner level from the profit or loss reported on a K-1. 

 

One Final Gotcha

I am neither an attorney nor a tax professional.  I am only familiar with how dozens of my customers deal with aircraft tax issues (and probably so does your accountant). This information is provided for general information and should not be considered current or be construed as legal advice or opinion on any specific circumstances.  Consult an attorney, your accountant or an aircraft tax specialist about specific legal question you may have.When you want to choose a good airplane and want to hire me for that purpose, please email swilson at stephentwilson dot com.
This is a 20-year-old portrait of the writer, Steve Wilson, neither an attorney nor tax expert.

 

 

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