Maximizing the deduction for personal use of an aircraft.

With the promulgation of the American Jobs Creation Act of 2004 (AJCA), the deductibility of expenses for the personal use of an employer-provided aircraft has been severely limited. Under prior law, a company was allowed a full deduction for such use if the employee recognized in income an amount based on a fair market value (FMV) or standard industry fare level (SIFL) value that generally was significantly less than the deduction claimed. After the AJCA, this disparity has been eliminated; a company generally cannot deduct an amount in excess of the income the individual recognizes.

Notice 2005-45 provides rules and allocation methods to correctly apply the deduction limit; however, potential planning opportunities also arise.

Entertainment Use

Under Sec. 274(a)(1)(A), no deduction is allowed for an activity generally deemed to be entertainment, amusement or recreation, unless the taxpayer establishes that it is directly related to or associated with the active conduct of a trade or business. Sec. 274(a)(1)(B) disallows deductions for facilities related to such activities.

Intended to overturn the decision in Sutherland Lumber-Southwest, Inc., 114 TC 197 (2000), aff'd, 255 F3d 495 (8th Cir. 2000), acq., AOD 2002-02, AJCA Section 907'S amendments to Sec. 274(e)(2) and (9) specifically disallow expenses related to entertainment facilities to the extent "specified individuals" do not recognize the related income. Thus, if a specified individual does not recognize as income the full amount of an entertainment-related deduction, the excess cannot be deducted. However, an individual can reimburse the employer for the specified amount to allow deductibility.

Specified Individuals

Under Notice 2005-45, a "specified individual" is either an individual who is subject to Section 16(a) of the Securities Exchange Act of 1934 or one who would be so subject if the company issued equity securities. This includes every person who is:

* The direct or indirect beneficial owner of more than 10% of any class of a registered equity security;

* A director or an officer;

* The direct or indirect beneficial owner of more than 10% of any class of a registered security if the company were an issuer of securities; or

* A person comparable to an officer or a director.

For partnership purposes, a specified individual is a partner who holds more than a 10% equity interest in the partnership, a general partner, an officer or a managing member of the partnership. For purposes of identifying specified individuals, Secs. 267(b) and 707(b) related-party rules apply. In addition, a specified individual is a spouse or family member of a specified individual, or another person who has a personal relationship with a specified individual.

Expenses Subject to Disallowance 

Notice 2005-45 states that all the costs of maintaining and operating an aircraft (both fixed and variable) are subject to the disallowance rule. This includes, but is not limited to, fuel costs; salaries for pilots and maintenance and other personnel assigned to the aircraft; flight personnel's meal and lodging expenses; take-off and landing fees; costs for maintenance and maintenance flights; costs of on-board refreshments, amenities or gifts; hangar fees (at home or away); management fees; depreciation; amounts deductible under Sec. 179; in the case of chartered aircraft, all costs billed for the charter (including amounts for flight time, waiting time, fuel and overnight expenses); and, in the case of leased aircraft or other leased equipment, lease payments.

Expense Allocation

The total expense related to the aircraft must be allocated between business and personal use by a specified individual, using either occupied seat hours or occupied seat miles (i.e., the sum of the hours or miles flown by an aircraft multiplied by the number of seats occupied) . The ratio of personal use by a specified individual is then multiplied by the total aircraft expense. The chosen method must be used consistently for the tax year.

The disallowed expense is the amount that exceeds that included in compensation or reimbursed by the specified individual. An aircraft returning empty from a flight after discharging passengers or traveling empty to pick up passengers (a "deadhead" flight) is treated as having the same amount of seat miles or seat hours as the legs of the trip in which passengers were aboard.

Bifurcation: A special bifurcation rule exists for expenses attributable to both business and entertainment. The entertainment cost is the excess of the total cost of the flights (by occupied seat hours or miles), less the cost of the flight that would have been taken without the entertainment segment(s).

Planning Considerations

Generally, the entertainment use of an aircraft does not depend on the tax implications of using the aircraft for such purposes. However, consideration of the methods available can produce favorable tax results, by lowering the allocation fraction attributable to personal use. Due to winds, flight times can differ substantially, depending on the direction of travel. This factor becomes useful when the business portion of a trip is longer than the personal portion due to wind resistance.

Example: X, a specified individual, travels from New York to Los Angeles on business. He is the only traveler and flies for four hours. On the return trip from Los Angeles, X stops in Chicago for personal entertainment, then heads to New York. Due to a tail wind, the total return time is also four hours.

Because the notice states that the disallowed cost of a flight that is both business and entertainment is the "excess of the total cost of the flights ... over the cost of the flights that would have been taken without the entertainment segment or segments," it appears that no amount is disallowed, because, using the seat-hour approach, the entertainment portion is no greater than the business portion. Under Regs. Sec. 1.61-21(b) and (g), an employee must recognize income to the extent of a trip's FMV or a value computed using the SIFL guidelines. The example's facts produce the same deduction consequences as under pre-AJCA law.

In addition, planning can reduce the deduction limit for deadhead flights. Under the notice, the cost of an empty plane after discharging passengers or before picking them up equals the cost of the portion of the flight that held passengers.This could potentially create a large deduction disallowance, depending on how far the plane travels for personal use when boarded and how many travelers are aboard. However, this rule does not apply unless there is a deadhead leg to the trip.

Conclusion

Notice 2005-45 provides guidance on how to allocate costs associated with personal use of an airplane. Under these guidelines, opportunities exist to increase the amount of deduction a taxpayer may claim. By understanding the costs associated with a business trip, an individual can plan personal use that dramatically reduces the amount subject to disallowance.

From Joshua C. Ebner, CPA, MST, Oakbrook, IL