Change in IRS Position Creates Additional Tax Exposure for Aircraft Management Companies and Aircraft Owners

Earlier this year, the Internal Revenue Service issued a Chief Counsel Advice (CCA 2012-10026) that addresses the taxability of aircraft management fees as amounts “paid for the taxable transportation of persons” that are subject to the 7.5% Federal Transportation Excise Tax imposed by §4261 of the Internal Revenue Code (the “FET”). The CCA’s analysis suggests that the IRS will insist that aircraft management companies collect FET on management fees and other amounts paid by owners under most garden-variety aircraft management arrangements. This is an unwelcome surprise, not only for management companies (which had assumed -- for decades -- that no such obligation existed), but also for their aircraft owner clients. In light of the CCA, management companies and owners may want to consider reviewing and re-casting their aircraft management arrangements – before the issue comes up on audit.

The CCA focusses on what were hitherto considered very customary arrangements between aircraft owners and aircraft management companies. In the scenarios addressed in the CCA, an aircraft owner hires a management company to manage aircraft operations, perform maintenance, and ensure regulatory compliance. The management company also provides qualified pilots, who are employees of the management company. The owner pays a monthly management fee and an hourly fee for each hour of flight time. In addition, the aircraft owner reimburses the management company for the costs of employing the pilots and any crew and for pilot training. In one of the scenarios, the management company is allowed to charter the aircraft to third parties under Part 135 of the Federal Aviation Regulations when the owner is not using it, and the management company and owner share the charter revenue.

The CCA concludes that the amounts paid by the aircraft owner to the management company under the described scenarios, including management fees and a variety of costs separately reimbursed by the aircraft owner, are subject to the FET. Because such payments are subject to the FET, the management company has the obligation to collect the FET from the aircraft owner and remit the collected tax to the IRS. Should the management company fail to do so, the FET can be collected from the management company directly by the IRS. 

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Maine Supreme Court Clarifies Aircraft Exemptions

Special thanks to Joseph X. Donovan, tax attorney at Sullivan & Worcester, for his contributions to this post.

In two decisions issued on the same day, the Maine Supreme Judicial Court has reached contrary conclusions on the taxability of aircraft purchased outside the state but used in Maine on more than a de minimis basis in the year following purchase.

In Blue Yonder, LLC v. State Tax Assessor, Dkt. No. BCD-10-3 (April 26, 2011), a Massachusetts-organized limited liability company (“Blue Yonder”) owned by a husband and wife purchased an aircraft in Minnesota, and the husband flew it to Massachusetts, where it was registered. No sales or use tax was paid in any state.  The husband thereafter rented the aircraft from the LLC for business and personal use and also for use in so-called “angel flights,” delivering patients to places of care in Massachusetts.

During the first 12 months of ownership, the aircraft was present in Maine, where the husband and wife owned properties, about 21 days, or about six percent of the time.

The court first considered and rejected as controlling two exemptions: (1) a provision covering aircraft “purchased by a nonresident and intended to be … transported outside the State immediately upon delivery” (36 M.R.S.A. Sec. 1760(23-C)(C)); and (2) a provision covering sales with respect to which “the seller delivers the property to a location outside this State” (36 M.R.S.A. Sec. 1760 (82)). These exemptions, the court concluded, only apply in the case of in-state sales.  This interpretation may open the court’s logic up to later constitutional challenge, because it is difficult to see how, under the Commerce Clause, a taxpayer can be better off, all other things being equal, just by virtue of a sale having taken place in the state.

This interpretation was not determinative of the outcome in the case, however, because the court went on to hold that Blue Yonder was entitled to claim exemption from tax under a provision that applied when property was “purchased and used by the present owner outside the State … [f]or more than 12 months.”  36 M.R.S.A. Sec. 1760(45)(B).  The court reasoned that this exemption could not be conditioned on exclusive use outside Maine during the 12-month period, because the legislature would have expressly required such use if it so intended.  Nor was it willing to adopt a bright-line number-of-days test. (The Maine Legislature subsequently did adopt a bright-line test, under which an aircraft may not be present in the state for more than 20 days during the 12 months after its purchase if it is to be exempt.)  The court concluded, rather, that it was appropriate to adopt a requirement that the use outside the state be “sufficiently substantial” to make the imposition of the use tax “unjust.”  Under this test, the court found Blue Yonder’s use of the aircraft outside the state for about 94% of the time to be sufficiently substantial for the exemption to apply.

In contrast, in Victor Bravo Aviation, LLC v. State Tax Assessor, Dkt. No. BCD-10-2 (April 26, 2011), during the year subsequent to its purchase, the aircraft in question was in Maine overnight on 121 occasions, and in Maine for the entire day on 89 days.  Moreover, it was sometimes placed in a hangar owned by the taxpayer and located in Maine.  On these facts, the court ruled that the aircraft was not used so substantially outside of Maine during the first 12 months of ownership that it would be unjust to impose the tax.

Readers may want to note that the Maine law at issue in Blue Yonder and Victor Bravo in at least two respects is eccentric, and not likely to be replicated in many states:

 

Ø      The aircraft in both cases were rented or leased. In most states, the purchaser would have been entitled to buy the aircraft tax free for resale in the regular course of business, and then would have charged tax, if at all, on the rental or lease payments it received from its customers. Because Maine law generally treats a lessor as subject to tax on its purchases, the taxpayer in Victor Bravo, for example, was hit with a tax based on its entire purchase price, rather than just on the rental stream it collected with respect to Maine transactions.

 

Ø      It is unusual for a court to adopt an ad hoc interpretation of use outside the state that is as generous to the taxpayer as the “sufficiently substantial” test applied in these cases.  Rather, in many states, a similarly-situated taxpayer would run the risk that any use in the state beyond a de minimis level could trigger a tax.

 

 

 

Helpful Amendments to Florida Sales and Use Tax Laws

Florida has recently made changes to its sales and use tax laws that will affect - in a positive way - owners and operators of aircraft. 

Florida assesses a 6% sales tax on tangible personal property sold in Florida or used in Florida. The sale of an aircraft in Florida will attract Florida sales tax in the absence of an exemption. Although Florida does provide a number of aviation-related exemptions, there have been proposals to either cap or reduce the tax rate for aircraft to make Florida more competitive with neighboring states. Although the recent Florida amendments don’t go as far as some would have liked – they don’t, for instance, contain the broad tax cap that was sought and obtained by the yachting industry - they are helpful nonetheless. The amendments affecting aircraft (described in a recent Florida Department of Revenue publication) include:

  • A cap of $300 on the tax that can be imposed on the sale or use of a fractional ownership interest in a fractional aircraft ownership program. Note that the fractional program must meet the requirements of FAR Part 91K, and also that the fractional program must have at least 25 aircraft in its fleet. In addition, the sale to or use by a fractional program manager operating a qualifying fractional program of any parts or labor used in the completion, maintenance, repair or overhaul of a fractional program aircraft also will be exempt from Florida tax (subject to registration and certification requirements).
  • A 20-day use tax exemption. This exemption allows a nonresident of Florida to avoid Florida use tax on his or her aircraft, so long as the aircraft enters and remains in Florida for no more than a total of 20 days during the 6-month period after the date of its purchase.   Florida already presumes that an aircraft used in another state or territory of the United States or in the District of Columbia for six months or longer before being brought into Florida is not subject to use tax in the state. Under the new exemption, the number of days the aircraft remains in Florida only for flight training, repairs, alteration, refitting or modifications does not count against the 20-day limit. The 20‑day exemption was intended to address concerns that the lack of clarity in the Florida use tax law was deterring aircraft owners and operators from using their aircraft to visit Florida.

The Florida amendments came into effect on July 1, 2010.

Extension of 50% Depreciation Allowance for Business Aircraft

On February 17, 2009, President Obama signed into law The American Recovery and Reinvestment Act of 2009.  Of particular interest to the aviation community is the Act's one-year extension of the 50% bonus depreciation allowance.   To qualify, aircraft must be placed in service by December 31, 2009 (rather than December 31, 2008, as was previously the case).   For "certain aircraft" (that is aircraft with a cost exceeding $200,000 and an estimated production period exceeding four months), aircraft must be placed in service by December 31, 2010 (rather than December 31, 2009).

Sales of Aircraft Fractional Interest - Tax Recapture

Given the economic climate, some business aircraft owners are thinking of disposing of their aircraft. A sign of the times, unfortunately. This post is first in a series that flags some issues that tend to pop up in the context of aircraft dispositions. The first few posts will focus on dispositions of interests in aircraft under fractional ownership programs.

• Budget for recapture of tax depreciation. Most owners are well aware of the tax benefits associated with the use of aircraft in their businesses - particularly the allowances for bonus depreciation and accelerated depreciation. Given that business aircraft operated under Part 91-K may qualify as 5-year MACRS property, some owners may have a zero basis. If you have a low tax basis you should keep in mind that the sale of your interest may trigger the recapture of the depreciation allowance, and that this will be treated as ordinary income – not capital gain – for federal income tax purposes. If you have purchased (or expect to purchase) another aircraft or interest you may be able to avoid recapture through the use of a like-kind exchange – but if you are simply looking to put your days of aircraft ownership in your rear view mirror, a like-kind exchange is not the answer.