IRS discusses amount deductible for use of private plane.

Businessman X is sometimes required to travel away from home on business. For a number of years, X has claimed substantial losses attributable to S corporation A on his individual Federal income tax return. A has been identified as an "airplane charter." Until several years ago, X was A's sole shareholder. Since then, Trust C (apparently X's grantor trust) has been A's sole owner. C also owns B, a Subchapter C corporation, which, is X's personal service corporation.

A owns several airplanes not available for lease to the general public. A does not have a Federal Aviation Agency Part 135 license (which is apparently necessary to lease the airplanes to the general public). Instead, the airplanes are almost exclusively used by X and his family.

The only income earned by A comes from B. B negotiates contracts for X's services and arranges for X's travel. X uses the aircraft owned by A to fly to business locations. Sometimes specific amounts are negotiated to pay for the cost of X's travel with the companies that employ him. X, who is a pilot, also uses the airplanes for personal reasons. The amounts attributable to X's personal use of the airplanes are not deducted by A.

A has never shown a profit and has instead sustained losses each year. There is evidence that the amounts paid from B to A for use of the airplanes is less than their fair rental value. To make up for shortfalls in prior years, X has deposited amounts in A'S bank accounts.

X asserts that he needed to fly by private charter to meet his business commitments and, further, that owning his own airplane was superior to hiring a private charter company. Convenience, cost and safety were the reasons given.

X argues that it was more convenient to fly by private charter because he was often in remote locations, and there were no private charter companies in the vicinity. Although his schedule was often known well in advance for certain events, others would come up on short notice, and commercial flights, with their delays and lack of connections, were far too inconvenient. Private charters also allowed him to work while on the airplane without the distractions of public intrusions.

X also argues that it could actually be more costly to hire a private charter than to use his own plane. He gives two examples. First, when there are no private charter companies in the vicinity, X would have to pay for the flight to bring the plane to him, and then for the return on the airplane to the home city. Second, if X had an appointment in a distant city and used a private charter, he would need to choose to either pay the charter company for the airplane to wait for him, or send the airplane back to its originating city. The cost of the flight and the waiting time would likely exceed the amount paid by B to A, because B paid only for flight time.

X also believes it is safer for him to fly by private charter because of his celebrity status.

Analysis

Sec. 162(a)(2) allows as a deduction all the ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business, including traveling expenses (including meals and lodging other than amounts lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business. Under Regs. Sec. 1.162-2(a), only such traveling expenses as are reasonable and necessary in the conduct of the taxpayer's business and directly attributable to it may be deducted.

The underlying issue is whether B's payments to A for air travel are ordinary and necessary business expenses under Sec. 162(a). Of particular concern is whether they are reasonable in amount, which is required for them to be ordinary and necessary. If the payments are ordinary and necessary, B may deduct them in full. If they are not reasonable and (for that reason alone) not ordinary and necessary, B may only deduct the cost of first-class airfare.

In Kurzet, 222 F3d 830 (10th Cir. 2000), taxpayers claimed the costs of a personally owned Lear jet as ordinary and necessary expenses of a timber farm, a consulting business or a computer and real estate rental business.

The potential business use of the jet included flights to a timber farm in Oregon and to condominiums in Park City, Utah. The court found that the expenses of purchasing, maintaining and operating a personal Lear jet to make a few trips each year to Oregon and Utah were extraordinary. Further, the court regarded the inconvenience the taxpayers would have experienced flying to their timber farm in Oregon "as minimal, as ordinary and as common, both for individuals and for businessmen," especially because the timber farm was not currently earning income. The travel to Park City on the Lear jet was rejected as either extravagant or personal (relating to the taxpayer's skiing and personal residence there). The court allowed the otherwise ordinary and necessary travel to the timber farm based on first-class airfare.

The Tenth Circuit reversed the Tax Court's disallowance of the cost of the Lear jet to fly to the Oregon property, but did not criticize the Tax Court's allowance of first-class airfare in lieu of a showing that the expenses attributable to an alternative means of travel by air were reasonable.

First, the Tax Court should not have considered the airplane's depreciation when determining whether its expenses were unreasonable. Second, the Tax Court had underestimated the number of trips the taxpayers had taken to Oregon by at least half. Lastly (and most significant to the present case), the Tenth Circuit found that the Tax Court did not give sufficient weight to the time savings associated with use of the Lear jet. The Tenth Circuit took the number of hours saved by flying by personal Lear jet during each year, multiplied it by the value of the taxpayer's time on an hourly basis and added the result to the cost of first-class travel. The Tenth Circuit then compared this sum with the expenses deducted for the Lear jet and found that the actual costs of the Lear jet for the trips to Oregon were reasonable.

Thus, the Tenth Circuit retained the reliance on first-class airfare as a standard for reasonableness in determining ordinary and necessary travel expenses. The fair market value of a taxpayer's time, which the Tenth Circuit added to the first-class travel for the purposes of comparison, would not be de-ductible.

Conclusion

If B's payments to A for X's air travel are found not to be reasonable, the amount of deduction allowable should be limited to the cost of first-class travel (rather than the cost of private charter).

IRS LETTER RULING (FSA) 200137002 (5/9/01)