Year: 2010

Tax Court Takes Aim At Leasebacks As Sufficient “Business Use”

A common way for aircraft owners to defray the costs of ownership and justify the business use of their planes is through “leaseback” agreements. A leaseback agreement is one in which the aircraft owner agrees to let a flight school – often the same facility or company that sold them the plane – use the plane for their students. The owner takes a small premium over the direct costs of the flight for each hour, which can generate some to modest revenue, depending on the type of plane and the market for flight lessons.

While aircraft owners must concern themselves whether the income this generates is “passive”, there is usually less dispute as to whether the leaseback arrangement is a bona fide business arrangement for purposes of taking business related deductions and allowances, like the Section 179 expensing allowance that produces considerable tax savings in the year in which the plane is placed in service.

The Tax Court, in a Memorandum opinion: Tax Practice Mgmt., Inc., et al. v. Commissioner, TC Memo 2010-266, took exception to the taxpayer’s expensing allowance for lack of a profit motive in its leaseback arrangement. The taxpayer was in the tax preparation business and had offices in multiple states. He testified at trial that his intention in purchasing the plane was to facilitate travel to and from his different offices and support his overall business operations. He stated that he never intended for the leaseback activity to produce more than a small amount of income to offset the plane’s costs.

The court looked to the facts and circumstances of this case in upholding Respondent’s argument that the taxpayer lacked the requisite intent. At the time of purchase, Respondent argued, the taxpayer was in the process of selling the business for which he claimed to have purchased the plane. The Court further noted that the taxpayer used the plane only once in the year in which it was placed in service (late in the year), for a test flight.

Most notable about this opinion was the court’s focus on whether the taxpayer intended to make a profit with the airplane rather than with his tax preparation business. This is an unfortunate decision in that many aircraft purchasers have considerable, bona fide business use for their planes as business tools, and not because they are looking to enter the aviation business per se. The court seemed to place undue emphasis on whether the lease to the flight school was sufficient in and of itself to show the requisite profit motive.

Lesson learned? Here’s a few suggestions: (i) If you’re hot to close on your aircraft purchase prior to the end of the year, stop. The court in the opinion above found the taxpayer’s minimal use of the plane in which the expensing allowance was taken persuasive in accepting Respondent’s argument that there was no “profit motive” in buying the plane. Take your deductions in years for which you can establish a track record of using your plane for business; (ii) Establish in advance, preferably in a written business plan, how the aircraft fits into the business’ overall profit motive. Highlight the differences between the larger business of which the plane is a part, versus the ownership and leasing of the plane as a business unto itself. This is a critical distinction that can save you from a result similar to what occurred in Tax Practice Mgmt.

Ari Good, Esq. practices in aviation tax law, including in defending aircraft businesses and owners in federal income tax and state sales and use tax audits. For more information visit our aviation and tax pages.

Bonus Depreciation Extended

President Obama last week signed the Small Business Jobs Act of 2010 into law, extending two key aircraft-friendly tax provisions for another year.  This legislation extends the “bonus depreciation” provisions that have been in place for some time that allow the taxpayer to deduct up to 50% of the purchase price of the plane in that year.  This legislation will also modify the separate “expensing” provision that allows up to an additional $50,000.00 deduction.  What remains of the plane’s basis is then further depreciated under the accelerated, five year, MACRS recovery period.  Put together, these provisions allow an aircraft purchaser (including fractional interest purchasers) to deduct the majority of the purchase price of within the first two years.

The taxpayer must qualify for these benefits, and there are some limitations: 

  • These provisions apply only to noncommercial aircraft predominantly used in a trade or business.  Personal use is accounted for separately and should be undertaken with professional tax advice.
  • The expensing allowance, under the new law, phases out dollar for dollar for aircraft over $2M. 
  • Bonus depreciation is permitted only for new aircraft, whose “first use” is in the taxpayer’s hands.  Used or refurbished aircraft do not qualify.  Fractional interests are considered “first used” by the taxpayer at the time of his purchase.
  • You must enter a written binding contract for his purchase of the plane and place a non-refundable deposit with the seller by the end of this year.  You would have to begin using the aircraft by the end of next year.
  • Depreciation deductions are “recaptured” when the aircraft is sold.  This can be deferred for some time either by continued ownership or by exchanging the fractional interest for another at a later time.  The real tax savings is the time value of the money not paid in taxes during this period.

Ari Good, Esq.

General Aviation Caucus Lobbies For New York GA Competitiveness

New York, like Florida, may be beginning to draw back from policies that punish general aviation in the state. Aircraft buyers routinely go to Connecticut, which does not charge sales tax on larger aircraft, in order to save considerable sales tax upon purchase. While aircraft rentals are subject to use tax when returned and based in New York, aircraft owners still have the option to base aircraft nearby. This results in a loss of revenue in the form of annual inspections, hangar leasing and other activity crucial to the economy of New York.

Avoiding IRS Audit Red Flags – How Does the IRS Select Returns For Audit?

IRS audit red flags
How does the IRS select returns for audit?

How Does The IRS Select Tax Returns For Audit?

What types of audit red flags does the IRS use to select returns for audit?  Under its “National Research Program” the IRS first comes up with a “baseline”, or theoretically acceptable, return for different types of taxpayer profiles.  The IRS uses special software to select returns that vary significantly from this profile.  This “DIFF” (Discriminate Function System) software assigns each return a “DIFF Score”.

The Service changes its algorithm from time to time.  While the IRS does not release the particulars of this process, it is common for taxpayers to learn what are the common “red flags” based on the types of audits people start seeing in the field.

From there an IRS auditor conducts an initial assessment of the computer-selected returns. The auditor determines whether to accept the return as-is or to select the return for audit.  If the IRS selects your return for audit you will receive a notice to this effect.

Can you avoid IRS audit red flags?  Yes and no.  Keeping your tax reporting consistent year over year will help.  We believe that large increases or decreases in income may affect your DIFF score.  Now, this hardly means you did anything “wrong”.  It simply identifies your return as one which may merit more attention.  Income that attracts attention is better than less that goes unnoticed.  Your industry also may affect whether the IRS selects your return for audit.  At present, real estate professionals (adding insult to injury perhaps) are being targeted for audit by the IRS.

You can get IRS tax help.  An important thing to remember is you have the right to be represented if your return is selected for audit, and you should.  There are both strategic and practical nuances to the audit process.  There is, as they say, a time and season for different approaches.  Sometimes cooperation is in order, sometimes it’s necessary to fight back.  A lot depends on the issue and the auditor.

Contact me for an overview of the tax audit process and what you might expect if your return is selected for audit.

NBAA’s Handy State Tax Guide

The National Business Avaition Association publishes a very handy “quick reference” tool to state laws concerning aircraft sales and use tax, aircraft registration, fuel tax and related tax issues. This service is free to NBAA members with usernames and passwords to www.nbaa.org. This service resembles, though certainly doesn’t replace, a similar compilation available through publisher Conklin & DeDecker.

Whatever resource you use, however, must be current as to recent tax law changes. Florida only recently, for example, created new provisions governing sales and use tax applied to aircraft returned here within 180 days of purchase. Contact a qualified aircraft tax advisor for details and the most recent updates. Also visit our website, at https://www.goodattorneysatlaw.com/aviation.html.