Scenario for Company ABC

Dear Aviation Attorney:

I am the manager of Company ABC's new flight department. We are planning to acquire and operate an XYZ turbine aircraft. I expect that there are many legal and tax planning issues we should consider. Can you help?

Sincerely,

Duly Diligent

Flight Department Manager

Advice for Company ABC

Dear Duly Diligent:

Thank you for your letter. We would be pleased to advise you and Company ABC on legal and tax planning issues. Here is a summary of typical corporate flight department issues to get us started.

 

1. FAA Issues

The aircraft must be registered when it is purchased. Assuming that the aircraft will be registered in the United States, the new owner must meet the U.S. citizenship or alternate requirements for aircraft registration. If the company purchasing the aircraft is a limited liability company, the FAA Registry will require supporting citizenship and authority documents in addition to the aircraft bill of sale and the company's aircraft registration application.

From an operating and maintenance standpoint, safety is the primary concern of the FAA. The company flight department is responsible for strict compliance with applicable operating and maintenance rules.

Most company flight departments operate their aircraft under the noncommercial operating rules of Part 91 of the Federal Aviation Regulations (FARs). FAR Part 91 does not allow operations in common carriage. Common carriage is defined as the holding out of a willingness to transport persons or property from place to place for compensation. FAR Part 91 also prohibits non-common carriage operations for compensation, with certain exceptions.

The exceptions most important for company flight operations are contained in FAR 91.501. This regulation applies to large and turbine-powered multiengine airplanes. "Large aircraft" means aircraft of more than 12,500 pounds maximum certified takeoff weight. U.S. registered small airplanes that are not

turbine powered, multiengine airplanes and helicopters may operate under FAR 91.501 as well, using the NBAA Small Aircraft Exemption.

Under FAR 91.501, the following arrangements are typically used by company flight departments to provide limited transportation for compensation: 1) parent-subsidiary; 2) time sharing; 3) interchange; and 4) joint ownership.

The parent-subsidiary rule in FAR 91.501(b)(5) allows a company operator to charge for the carriage of officials, employees and guests of certain related companies the cost of owning, operating and maintaining the airplane, so long as the carriage is within the scope of and incidental to the business of that company. The aircraft, however, should not be operated by a "flight department company" set up solely to operate the aircraft for others.

FAR 91.501(b)(6) and (c)(1) permit time sharing, an arrangement whereby a person leases his airplane to another person and no charge is made except for those permitted under FAR 91.501(d). The permitted charges are basically two times the cost of fuel plus certain limited expenses.

FAR 91.501(b)(6) and (c)(2) permit interchange, where one person leases his aircraft to another person in exchange for equal time on that person's aircraft for a charge not to exceed the difference between the cost of owning, operating and maintaining the two aircraft.

FAR 91.501(b)(6) and (c)(3) permit joint owners, where one of the registered joint owners of an airplane employs and furnishes the flight crew for that airplane and each of the registered joint owners pays a share of the charge specified in the agreement. In addition to the FAR Part 91.501 options, a Part 91 aircraft operator can "dry" lease an aircraft to another for compensation. A dry lease is a lease of the aircraft without crew.

Leases of large aircraft are generally subject to the Truth In Leasing requirements of FAR 91.23. This regulation would apply to the time sharing, interchange and dry lease arrangements described above.

Some flight department companies desire to use their aircraft in commercial operations some or all of the time but do not desire to obtain and maintain their own commercial FAA operating certificates. An aircraft charter management arrangement can accomplish these goals. In a typical charter management agreement, the aircraft owner allows the management company to operate the aircraft under the manager's FAA Operating Certificate for commercial flights. The management company charges the commercial customer and provides some compensation to the owner.

 

2. Federal Transportation Excise Tax

Section 4261 of the Internal Revenue Code imposes a 7.5 percent tax plus a segment fee on commercial air transportation. Generally, any time an operator provides an aircraft with crew, the transportation tax and segment fee may apply. Any flights that are not taxable pursuant to Section 4261 are taxable pursuant to the fuel tax found in Section 4041 of the Internal Revenue Code. The fuel tax is paid at the pump whenever fuel is purchased. Operators of flights subject to the transportation tax may then seek a credit or refund for taxes paid on fuel.

The most important exemption from the federal transportation excise tax for company flight departments is the "affiliated group" exemption. Internal Revenue Code Section 4282 exempts from the tax transportation by air for other members of the aircraft operator's affiliated group. An example of an affiliated group eligible for the exemption is a parent corporation that owns at least 80 percent of the stock in each of four subsidiary corporations, one of which owns an aircraft, employs pilots, and carries the employees of its parent and fellow subsidiaries for compensation. An organizational chart is helpful in determining how the exemption applies to a particular company.

The Internal Revenue Service (IRS) has decided that it is not bound to follow the FAA's determination of what constitutes commercial air transportation. Therefore, even though most of the arrangements discussed above are noncommercial for FAA purposes, the federal transportation excise tax may apply. Specifically, the tax applies to parent-subsidiary operations unless the affiliated group exemption applies. The tax generally applies to time sharing and interchange. Joint ownership operations are typically not subject to the tax. A dry lease is not subject to the tax. For the typical charter management arrangement described above, the commercial customer's flights are subject to the tax. The management company typically takes care of collecting, reporting and remitting the tax to the IRS.

 

3. Federal Income Tax Issues

Federal income tax considerations are important in planning for and administering aircraft ownership and operations. In particular, business aircraft have the potential to give the relevant taxpayer substantial income tax deductions from depreciation and other expenses. Classification of the aircraft as property used in the trade or business, and characterization of the aircraft expenses as trade or business expenses, are important first steps. The aircraft tax depreciation schedule then depends on factors such as whether the aircraft is used for commercial or noncommercial operations, for primarily business or primarily personal purposes, and primarily within or primarily outside of the U.S. Aircraft maintenance must also be characterized to determine whether to capitalize or expense the costs involved. After determining the deductions possible, it is important to examine IRS limitations such as basis, at-risk, and passive activity loss limitations to determine the ability of the taxpayer to use the aircraft-related deductions. When the company is ready to trade in its aircraft, the like-kind exchange rules of Section 1031 of the Internal Revenue Code may provide important tax benefits. Company ABC should work closely with its income tax advisors to maximize its position with respect to possible deductions.

 

4. Personal Use of the Company Aircraft

Personal use of company aircraft by employees, their spouses, family members and guests may result in taxable income to the employees. Under IRS income tax rules, if an employee does not reimburse the employer for the value of personal flights on board the company aircraft (as well as those involving a spouse, family member or guest), the value is imputed income to the employee.

As discussed above, however, the FARs governing noncommercial aircraft strictly limit the arrangements under which compensation may be accepted by the operator. Please note also that if Company ABC is a public company, personal use of the company aircraft may also have disclosure implications under the Securities and Exchange Commission rules.

 

5. Sales, Use and Property Tax and Aircraft Registration

Most states tax the purchase of aircraft and fuel, aircraft leasing and the storage and use of aircraft. However, Montana, New Hampshire and Oregon have no sales or use tax, and aircraft over 6,000 pounds certificated takeoff weight are exempt from sales and use tax in Connecticut. Some states tax services such as aircraft modification, refurbishment and repair.

Some states impose personal property tax on aircraft. In addition, a few states require their residents to register their aircraft and pay a fee based on factors such as value, weight, age and type of aircraft. Company ABC should determine where the aircraft will be purchased, used and stored and how it will be used for state and local tax planning purposes.

 

6. Pilot Qualifications and Employment

The company flight department is generally responsible for locating and engaging pilots who meet the requirements to operate the aircraft for the flights involved under both the FAA regulations and applicable insurance policies. The company should also determine whether the pilots will be employees or independent contractors. The employment status of the pilots has important legal, tax, insurance and administrative implications.

 

7. Liability and Insurance

The general rules of tort law apply to determine the liability of aircraft owners and operators. The standard of care is generally negligence standard, but may vary from state to state and country to country. Aircraft owners and operators may be liable for injuries to persons and property arising out of aircraft operations if their conduct does not meet the appropriate standard of care.

Aircraft owners and operators must carefully assess their potential liability exposure and aviation insurance needs to plan for appropriate and adequate insurance coverage. Company ABC should work with an experienced aviation broker, identify all persons and operations for which coverage is desired, and pay close attention to any arrangements involving compensation for use of the aircraft.