New IRS Taxation of Managed Aircraft: 4 Updates and 3 Questions for Aircraft Owners (Part 2 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 second part of a series on IRS taxation of managed aircraft and continues from a previous post, “3 Critical Things to Know about New IRS Taxation of Managed Aircraft.”
On March 9, 2012, the IRS released its Chief Counsel Advice Memorandum (“Memo”) stating that, in most common situations involving fully managed Part 91 aircraft, amounts paid by a U.S. aircraft owner (or lessee) to a management company may be subject to the 7.5% federal excise tax (“FET”). The Memo has generated a tremendous amount of concern and debate within the business-aviation community in the United States.
Much of the current debate is focused on what aircraft management companies should do to respond. At the National Business Aviation Association (NBAA) Forum in Van Nuys on April 12, 2012, a presentation on this issue was made by John Hoover, chairman of the Federal Tax Working Group of the NBAA Tax Committee. John also shared a draft paper entitled “IRS Chief Counsel Advice 2012-10026 States that Excise Tax Applies to Aircraft Management Service Arrangements.” Additionally, Phil Crowther has written an article entitled “An Analysis of the Recent IRS Chief Counsel Advise Asserting That Management Companies are Subject to Transportation Tax” which covers similar content to John Hoover’s topic. Both papers are available on the NBAA website.
Here are the salient points from that presentation, articles presented therein, and meetings afterwards that managed aircraft owners should know:
1. NBAA is working on the issue, but the future remains unclear
Representatives of the NBAA Tax Committee previously met with the IRS to attempt to help shape the IRS guidance on FET. Ultimately, the IRS issued its Memo without considering input from the business-aviation industry. On April 16, 2012, NBAA Tax Committee representatives again met with the IRS to discuss the Memo. The results of the meeting were inconclusive. The IRS generally agreed to future dialog, but no further guidance was provided.
2. There is some consensus among aviation-tax experts as to this IRS Memo’s impact
Despite much uncertainty about the future implications of the Memo, most aviation-tax advisors agree that:
- The Memo is not completely consistent with past IRS guidance.
- The IRS auditors will likely become even more aggressive in trying to assess FET on managed-aircraft arrangements.
- It may take time to resolve this whole situation with some degree of certainty.
3. Per the IRS Memo, aircraft owners must exercise control to avoid FET
The IRS Memo indicates the aircraft owner must exercise control over the pilots and have some actual control over the aircraft operations as well in order to avoid the FET, but it is unclear how sufficient control is achieved. However, it is likely the aircraft owner will have the necessary higher level of control over the pilots and aircraft operations in each of the following four scenarios:
- The aircraft owner owns the management company
- The aircraft owner is also one of the aircraft pilots
- The owner employs the pilots, and the pilots report to the owner
- The owner utilizes a 3rd-party pilot services company to hire the pilots
For most aircraft owners, only options 3 and 4 are viable.
If none of these options is practical, then the FET risk is increased. Simply amending the aircraft- management agreement alone is no guarantee that the tax will not be assessed. To help offset some of this increased risk, the developing advice is for the aircraft owner to exercise significant control over the pilots and use of the aircraft. One way to accomplish this may be a formal arrangement with the management company allowing the aircraft owner or the owner’s representative to exercise such control. It is suggested that ongoing documentation be created evidencing how the owner/owner’s representative is exercising its control authority.
4. There are currently two common responses to the FET
The FET is imposed on the person making a payment for transportation. In the case of a managed aircraft, the IRS now asserts the aircraft owner is “paying” for taxable transportation. Hence, per the IRS Memo, the management company should invoice and collect the tax from the aircraft owner. If the management company fails to collect the tax, the IRS can assess it against the management company, and the management company then must decide how to proceed against the aircraft owner for collection if the IRS assessment is successful. Unless or until the IRS issues further guidance on this matter, management companies have limited options on how to move forward. Two common responses under discussion are:
- Take no action. Some advisors believe that if a management company makes any significant change now, it is an admission of past guilt. However, if the current management agreement has some problems, this choice may run the risk of creating a less-defensible position if/when the management company is audited in future periods.
- Modify the management agreements and increase the aircraft owner’s extent of control. However, there is wide variance of opinion in how extensive the modifications should be and how much control should be given to the aircraft owner. Modification examples include: appoint the management company as the owner’s agent, have the pilots work directly for the owner or a 3rd party pilot services company, have the owner pay the aircraft expenses and take out its own insurance policy, and/or have the owner or their representative increase their involvement in decision making over the pilots and the aircraft.
We recommend that an owner of a managed aircraft request periodic updates from its management company on how the company intends to respond to this new FET situation.
Three important questions aircraft owners need to ask themselves:
- How much FET liability risk are you willing to accept? – This is really a two-part question and there is potential historical liability and future liability.
- How much additional control responsibility are you willing to accept? – This issue should be reviewed with your labor-law advisor since there may be co-employer implications related to some of the changes under consideration.
- How satisfied are you with your management company’s response to this issue?
If you have any questions about this article, contact me at firstname.lastname@example.org.