3 Critical Things to Know about New IRS Taxation of Managed Aircraft (Part 1 of 2)
This is a post by guest author Dave Weil, CEO and Founder of Flight Dept Solutions, LLC. Dave was asked to contribute to this blog because of his expertise in aircraft management and flight department issues. Any thoughts expressed below are entirely Dave’s and do not necessarily reflect the views of Universal Weather and Aviation, Inc.
This aviation blog post is the first part of a series on IRS taxation of managed aircraft.
On March 9, 2012 the IRS released new guidance affecting U.S. aircraft owners and lessees who contract with aircraft management companies to employ pilots and provide other services. The IRS now states that in most common situations nearly all amounts paid by an aircraft owner (or lessee) to a management company are subject to the 7.5% federal excise tax (FET).
In a sharp expansion of prior interpretation, this new guidance seeks to extend application of the FET to managed Part 91 aircraft operations of the owner. This change has the most potential impact on U.S.-based aircraft that fly predominantly within the continental U.S.
For example, if an aircraft owner pays a management company $1,000,000 for fees and cost reimbursements during a year, under this latest directive the FET on these payments may be as high as $75,000.
This announcement came in the form of an IRS Chief Counsel Memorandum, which in the IRS’ own words cannot be cited as a binding precedent, but does represent the IRS’ opinion. While the IRS historically considered certain FAA Part 91 operations taxable, this latest development raises a new level of uncertainty as to how broadly the IRS may assert the FET on an owner’s Part 91 flights when a management company is involved.
The 3 most important things to keep in mind about the IRS imposing the FET on Part 91 aircraft operations are:
1. FET may now apply to most costs, like crew salaries and benefits, and jet fuel maintenance
There are many different variations of aircraft management agreements in the marketplace today. In arrangements where an aircraft is fully managed, the management company employs the pilots. In most of these circumstances the management company likely exercises a level of control over the pilots such that the IRS now believes the FET applies. The IRS’ view is that the management fees, as well as all the separately reimbursed costs, are subject to the FET. Separately reimbursed costs include expenses such as crew salaries and benefits, insurance, training, fuel, and maintenance..
2. Follow the terms of your management agreement or face FET increases
Frequently, management agreements are carefully drafted to achieve a certain tax objective, but once they are signed the terms are not always followed. Even if an agreement is artfully drafted in such a way as to avoid or minimize the FET, if the agreement terms are not being followed, then the FET risk is increased.
3. IRS audits will be more extensive and broader in scope
Historically there has been wide variation in IRS approaches to an excise tax audit. Some auditors took a very narrow view and were not concerned with applying the FET beyond Part 135 charter flights. Some auditors were much more aggressive. It is expected that the latest IRS Chief Counsel Memorandum has the potential to increase the number of future audits and substantially broaden their scope.
Conclusion – Seek help
Every situation differs in regard to specific facts and circumstances. However, the new IRS position is so expansive that it impacts most existing fully managed aircraft arrangements. If you have a U.S.-based managed aircraft, it is now more likely that your management company will receive an FET audit from the IRS. Your management company should notify you of this issue and how they plan to address it. This is a complex tax matter. You should seek advice from an experienced aviation tax professional on how to deal with your existing management situation to avoid, or at least minimize, the chances of being assessed the 7.5% federal excise tax.
If you have any questions about this article, contact me at email@example.com.
Part 2 of this article will cover the key issues for owners of managed aircraft to consider, including changes under discussion for aircraft management agreements to deal with the tax threat posed by this new IRS position.