Note to Members
The information in this guide outlines basic tax issues for general aviation light aircraft owners and pilots. This subject report was written by Ray Speciale, who is a lawyer/CPA employed by Yodice Associates (AOPA Counsel), a law firm based in Frederick, Maryland. Ray is also an active pilot and flight instructor. The author gratefully acknowledges the assistance of Teresa Bazaral, Esq., in the preparation of the "Income Tax" section.
As always, you are urged to contact your tax advisor for answers specific to your tax situation. If you need help finding a tax professional with aviation experience in your area, call AOPA's Pilot Information Center at 800/USA-AOPA (872-2672). AOPA is not authorized to provide tax advice.
Over the years, AOPA has fielded numerous questions related to tax issues affecting aircraft owners and pilots. This publication is an attempt to review the basics related to income taxes, sales and use taxes, and personal property taxes as they might affect AOPA members.
Part 1 deals with income tax issues. This part is divided into different sections addressing issues related to aircraft expenses, flight training expenses, the "hobby loss" rule, and aircraft leasing. There is also a question and answer section addressing some of the more frequently asked income tax questions.
Part 2 tackles the basics of sales and use tax issues. Members purchasing aircraft are particularly concerned with potential liability for sales and use taxes. In this part of the booklet, we will explain the difference between sales and use taxes. A question and answer section with frequently asked questions follows.
Part 3 reviews the essentials of personal property taxes and registration fees. In this section, we have also included a listing of states that impose personal property taxes and/or registration fees.
It is important to keep in mind that this report will only provide you with general information regarding tax issues that could affect you as an aircraft owner and pilot. We urge you to consult with a tax professional regarding your specific tax questions. The report contains various citations and other resources to assist you and your tax professional.
Do you use an aircraft for business? Are you planning to use an aircraft in conjunction with a business? If your answer to either one of these questions is "yes," this section of our subject report applies to you.
The basic tax question posed by AOPA members who use aircraft for business purposes is whether their aircraft expenses are tax deductible. The types of expenses our members commonly look to deduct are the basic costs associated with aircraft operations, including maintenance, fuel, tie-down or hanger fees, landing fees, insurance, and depreciation.
In this section of our tax booklet, we'll discuss the law governing the tax deductibility of aircraft expenses, along with cases and rulings that can help you interpret the law. Next, we'll turn to the basic mechanics involved in taking your deductions (e.g., which forms you should use). Finally, at the end of this section, we've included citations and summaries of important cases and rulings for you and your tax advisor to review.
Governing Law and Interpretations
Internal Revenue Code (IRC) Section 162 tells us that "[t]here shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business...." As you might guess, this broadly worded law raises more questions than it answers. Therefore, in order to provide guidance as to whether your aircraft operating expenses are deductible, we have to turn to answers provided in cases and rulings which have attempted to interpret the law.
First of all, you must be using the aircraft for the purpose of conducting or "carrying on" a "trade or business" in order to get a tax deduction for the expenses of using a business aircraft. The IRC does not give us a definition of the term "trade or business." However, based on case law, a trade or business has been characterized generally as an activity you conduct for a livelihood or for profit. You must have a profit motive and be engaged in some type of economic activity to be carrying on a trade or business. Under our current tax laws, a corporation, partnership, limited liability company (LLC), or individual can be engaged in a trade or business.
Of even greater importance to many of our members, you should note that the tax law also allows an employee to be considered as being engaged in the trade or business of being an employee. This allows deductions to be available to you if you are an employee and use your aircraft to further your employer's business.
Once you've established that you're engaged in a trade or business, the next hurdle is convincing the IRS that your aircraft operating expenses are "ordinary and necessary." Never forget that if you take deductions for aircraft expenses, you have the burden of proving your entitlement to the deductions taken.
So how can you prove your aircraft expenses are "ordinary and necessary"? First, let's take a look at what qualifies under the law as an "ordinary" expense. Generally, the courts have held that an expense is ordinary if it involves a common and accepted business practice. In one decision, the court made it quite clear that they understood the use of private aircraft by executives to be a common practice, and therefore capable of qualifying as an ordinary expense. In this case, the court states that: "[i]n this day and age, there is no doubt that the use of private airplanes by executives in charge of large projects is common practice." (See Marshall v. Commissioner of Internal Revenue, T.C. Memo 1992-65.)
A more difficult challenge is proving that your aircraft expenses are "necessary." The courts have said that an expense must be appropriate and helpful for your business in order to be deductible as a necessary expense. In order to show that your aircraft was "appropriate and helpful" you'll have to be able to show how it provides you with direct access to your destinations, flexible scheduling, fewer overnight stays, etc. Oftentimes, this will be the most critical test of your aircraft expenses deductibility.
From our review of the pertinent cases, here are some suggestions we have for preventing (or dealing with) problems with the IRS.
How to Take Your Deductions
If, after reviewing the appropriate law, cases, and rulings, you decide that you have a legitimate claim to a deduction, your next step is reporting the deduction on the appropriate IRS forms. Our first and best bit of advice is not to do it yourself. The forms can be complicated, and some of the computations are difficult for amateur tax preparers. With this in mind, our review of this topic will be general in nature.
If you're an employee and you incurred aircraft expenses on behalf of your company, you should be using an IRS Form 2106 to report your expenses. On this form, you'll be able to record expenses like maintenance, fuel, tie-down fees, rental fees, and depreciation. Keep in mind, however, that not all of your employee business expenses including aircraft expenses will be deductible, because the IRS considers these expenses to be "miscellaneous" itemized deductions. Your miscellaneous itemized deductions are subject to a two-percent "floor" based on your adjusted gross income. This means, for example, that if your adjusted gross income is $100,000 and your employee business expenses from aircraft use are $5,000, you will be able to deduct only $3,000 of the total expense as an itemized deduction [$5,000 - ($100,000 x 2%)]. In some instances, this limitation may eliminate your deduction altogether.
If you are a self-employed sole proprietor, you will probably report all your business income and expenses on an IRS Schedule C. Your private aircraft expenses incurred for business purposes will be deducted from income, just as they would be on a corporate income tax return. Keep in mind that a Schedule C should not be used to report expenses you paid as an employee. We have seen many instances where employees have incorrectly used a Schedule C to report their aviation expenses. This attracts a lot of attention from the IRS because of the improper reporting.
A corporation with aircraft expenses will report them on an IRS Form 1120, U.S. Corporate Income Tax Return. If you're a shareholder in a Subchapter S corporation, any corporate deductions for aircraft expenses will be on an IRS Form 1120S and your share of corporate income and expenses will be reported on an IRS Schedule K-1 (Form 1120S), which will include instructions to help you report your share of the S corporation's income, credits, and deductions. A partnership with aircraft expenses will report deductions on an IRS Form 1065, U.S. Partnership Return of Income, with individual partner shares of income, credits, and deductions reported on a Schedule K-1 (Form 1065).
If you are the sole member of an LLC, you will report your revenue and expenses on a Schedule C in the same manner as a self-employed sole proprietor. An LLC with two or more members will typically report revenue and expenses on an IRS Form 1065 in a manner similar to a partnership.
Aircraft Expenses - Cases and Rulings
Flight Training Expenses
AOPA members frequently ask whether they can take a tax deduction for the cost of their flight training. This section of our tax booklet discusses the law and cases governing the tax deductibility of flight training expenses. We'll also identify and briefly discuss the appropriate tax forms to use when claiming deductions. At the end of this section we'll list and summarize some Tax Court cases that you can review with your tax advisor in order to help determine whether you are eligible to take a tax deduction for flight training expenses.
IRS regulations tell us that educational expenses may be deducted if the education (1) maintains or improves skills required in your employment, trade, or business; or (2) meets the express requirements of your employer or the requirements of applicable law or regulations imposed as a condition for your retention of salary, status, or employment (IRC Regulation 1.162-5(a)). However, even if educational expenses meet either of these two tests, they will still be nondeductible if they are incurred to meet the minimum educational requirements for your employment or if the education qualifies you for a new trade or business (IRC Regulation 1.162-5(b)2 and 3).
The first thing you'll notice in these regulations is that your flight training expenses will be deductible only if they are trade or business related. Therefore, if your flying is purely personal in nature, you will not be able to take a tax deduction for flight training expenses. If you fly professionally or use an airplane in your trade or business, you should first consider whether the flight training you received is either (1) needed to meet the minimum educational requirements of your present trade or business; or (2) part of a program of study that can qualify you for a new trade or business, whether or not you plan to enter that trade or business. If the answer to either of these questions is "yes," your flight training expenses will not be deductible.
Before you consider either of these questions, let's take a closer look at what the questions mean. First of all, you are not going to be able to take a tax deduction if the flight training you receive allows you to meet the minimum educational requirements of your employment. Therefore, if you plan on becoming a flight instructor, the training expenses you incur in getting your initial flight instructor certificate will not be deductible, because holding that certificate is the minimum educational requirement for employment as a flight instructor.
Also, if your training qualities you for a new trade or business, it will also be nondeductible. Quite often we hear from a member who uses an aircraft strictly for business or personal purposes. In order to improve her or her proficiency, the member gets training for a commercial pilot certificate. Unfortunately, even if you had no intention of becoming a commercial pilot, these training expenses would not be deductible, since the training qualifies you for a new trade or business as a commercial pilot.
If you can get by these first two hurdles, you must now consider whether the flight training you received was (1) necessary to meet the requirements of your employer (or of law or regulations) for keeping your salary, status, or employment; or (2) necessary to maintain or improve skills required in performing your current duties. In order for your expenses to be deductible, you must be able to respond "yes" to one of these questions. The first question will usually apply to you if you fly professionally. For instance, if you fly for a Part 135 operation and your employer requires you to take courses related to new aircraft systems, those course expenses should be deductible. Likewise, if you are a flight instructor and you attend a flight instructor refresher clinic, your course expenses should be deductible.
The second question may come into play when you use an aircraft for business trips and make an investment in an instrument rating in order to get better use out of your aircraft. The question now is whether the additional flight training maintains or improves the skills needed in your job.
There are a number of Tax Court cases that confirm the deductibility of this type of flight training expense. Similarly, the courts have also allowed tax deductions for training and proficiency flying required by the FARs.
In order to assist you and your tax advisor in analyzing whether your flight training expenses are deductible, we've developed a flow chart (below) that summarizes the regulations in a question-and-answer format.
Reporting Flight Training Expenses
If you are a self-employed individual, or the sole member of an LLC, you will report educational expenses on a Schedule C (Form 1040). Corporations report educational expenses on Form 1120, while Subchapter S corporations use Form 1120S. Partnerships and multiple member LLCs will use Form 1065.
Typically, educational expenses are incurred by employees who wish to take deductions for work-related education. If this is your situation, you'll have to use an IRS Form 2106 for employee business expenses. You should keep in mind that even if your flight training expenses qualify as deductible educational expenses, your deduction will be reduced by two percent of your adjusted gross income. So if your flight training expenses were $2,000 and your adjusted gross income is $40,000, you will be able to take a deduction of only $1,200 [$2,000-($40,000 x 2%)].
Are Your Training Expenses Deductible?
Flight Training Expenses - Cases and Rulings
The Hobby Loss Rule
Many of our members are using or would like to use an aircraft in an aviation-related business. The types of businesses involved include aircraft rentals, flight instruction, aerial photography, banner towing, and a host of other activities that involve the use of an aircraft. If you've ever considered putting an aircraft to work for you in a business, you should be aware of Internal Revenue Code (IRC) Section 183, better known as the "hobby loss rule." This rule applies to individuals, LLCs, and subchapter S corporations. If the IRS determines that your aviation activity is a hobby, expenses related to the activity are deductible-but only to the extent of the gross income from the hobby activity. Essentially, the IRS is saying that it's not going to allow a write-off of losses you've incurred while engaged in a hobby.
As you may have already guessed, it can be tricky to tell whether you are engaged in an activity for a profit under the IRS standards. The IRS regulations tell us that when making a determination as to whether an activity is engaged in for profit, it will look to all of the facts and circumstances of each case. The regulations go on to say that although a reasonable expectation of profit is not required, the facts and circumstances must indicate that you entered the activity or continued the activity with the objective of making a profit. The courts have further held that your profit making objective must be "actual and honest" in order for your activity to be considered as being for profit. In any case, there will be a presumption that your activity is for profit if you actually show a profit for three or more of the last five years in your business.
In an effort to assist you in determining whether an activity can be considered to be engaged in for profit, the IRS regulations list nine "relevant factors" which should be considered. The regulations caution that the listed relevant factors are not the only consideration to be taken into account when making a determination. In addition, the regulations also point out that a determination should not be based solely on whether the number of factors indicating a "for profit" intent exceed the number of factors tending to show a lack of profit motive. The nine relevant factors used by the IRS are (in pertinent part):
Again, you should keep in mind that these factors are not the IRS's only measure of whether your activity is for profit. However, it has been our experience that they do play a critical role in the IRS's disposition of questionable cases. Therefore, you should keep these factors in mind when planning or conducting your aviation-related business activity.
Another important issue to consider when using an aircraft for business purposes is whether or not to place the aircraft in a separate entity. Many aircraft owners do this thinking they will mitigate liability exposure or for other business reasons. One unintended consequence of operating the aircraft out of a separate entity and leasing it to the entity or entities that perform an underlying business function is the potential triggering of the hobby loss rule for the entity owning the aircraft. This is typically due to depreciation taken on the aircraft that causes a tax loss.
The IRS has taken the view that when it looks at profit motive, it will look to the particular entity that is generating the loss. When the IRS takes that approach, the aircraft owning entity may encounter difficulty when attempting to push back on a hobby loss challenge.
Results in federal courts have been mixed on this issue. In one relatively recent Tax Court case, Rabinowitz v. Commissioner, T.C. Memo 2005-188, the Tax Court sided with the IRS. Specifically, the Tax Court held that a stand-alone entity operating an aircraft charter business must be evaluated separately from the owner’s underlying business operation (a clothing business) when determining whether the hobby loss rules apply.
In two other cases, federal courts have reached a different result. In Campbell v. Commissioner, 868 F.2d 833 (6th Cir. 1989) the U.S. Court of Appeals for the Sixth Circuit determined that a partnership’s aircraft leasing activity should be considered together with other business activities of the partnership when determining profit motive under the hobby loss rules. The IRS never acquiesced in this case. Therefore its holding is limited to the Sixth Circuit. However, in another recent case in the U.S. Court of Claims, the Campbell case was relied upon in determining that an entity owning an aircraft and leasing it to several other business entities, should be viewed as part of an overall enterprise when determining profit motive (See Morton v. United States, 107 A.F.T.R. 2d par. 2011-762).
As is usually the case, good planning, with experienced and qualified legal and tax professionals is necessary when planning for how a business aircraft should be owned and positioned within an underlying business or multiple businesses.
Hobby Losses - Cases and Rulings
AOPA members often lease their aircraft in order to defray ownership costs. If you are already leasing your aircraft or if you're thinking about leasing your aircraft, this section of our booklet is for you. Our objective is to give you some general insights with respect to tax aspects of aircraft leasing.
The first thing to keep in mind is that your aircraft leasing activity should be supported by an honest intent on your part to make a profit. (See discussion on hobby losses above.) Remember, if the IRS views your aircraft leasing activity as a mere excuse to help support your avocation of flying airplanes, you will not be allowed to take tax deductions on any losses you incur in your leasing activity. Therefore, and we cannot emphasize this enough, you should not look upon your aircraft leasing activity as a way of creating a tax shelter. To do so will only invite trouble.
Of course, if your aircraft leasing activity is generating a profit, there are very few tax complications. The IRS is generally content to take their share of your profit, and you will be satisfied with the fact that your aircraft is producing revenue.
With this in mind, here are some tax considerations you should be aware of if your aircraft leasing activity does not turn a profit.
The first thing you should know is that you cannot take a loss deduction for any amounts that exceed what the IRS considers you to be at risk for in your aircraft leasing activity. Generally speaking, you are considered at risk in an activity to the extent of the cash and the adjusted basis (tax value) of other property you contributed to your aircraft leasing activity. Your at-risk amounts will also include amounts that you borrowed for use in the aircraft leasing activity if you are personally liable for the repayment of the borrowed amounts or the amounts borrowed are secured by property other than your aircraft. Therefore, in many cases, if you purchased an aircraft for cash, credit, or a combination of both, you would be considered to be at risk for the amount of the aircraft's purchase price.
The at-risk rules apply to individuals and to certain closely held C corporations. For purposes of the at-risk rules, a C corporation is a closely held corporation if, at any time during the last half of the tax year, more than 50% in value of its outstanding stock is owned, directly or indirectly, by or for five or fewer individuals. In the case of an S corporation, LLC, or partnership, the at-risk rules apply at the individual ownership level.
Once you've determined your allowable losses after applying the at-risk rules, you must now consider whether the IRS's passive activity loss rules will apply to your aircraft leasing activity. The passive activity loss rules were put into effect in 1987 in an effort by Congress to curb what they considered to be abusive tax shelters. The passive activity loss and credit rules limit the amount of losses and credits that can be claimed from passive activities. The rules prohibit individuals, estates, trusts, certain closely held corporations, and personal service corporations from deducting losses in excess of income generated by passive activities. Passive activity losses that are not deductible in the current year are suspended and carried forward to offset passive activity income generated in future years.
The IRS defines passive activities as trade or business activities in which you do not materially participate and rental activities, regardless of the level of your participation. Since most of us earn the bulk of our income through activities in which we materially participate (i.e. our jobs), it is generally to our advantage not to have any losses classified as passive activities. Therefore, in order to have your deductions effectively reduce your tax liability, you'll have to show that your aircraft leasing activity is not a rental activity. You will also have to show that you materially participated in your aircraft leasing activity. With this backdrop, you might be wondering how you can possibly demonstrate that your aircraft leasing activity is not a rental activity? This seemingly impossible task is made somewhat possible by specific exceptions to activities considered by the IRS to be rental activities. The exceptions discussed below seem particularly appropriate if you are the typical individual who is leasing his aircraft to other pilots through an FBO.
The IRS will not consider your aircraft leasing activity to be a rental activity if:
Also, the personal services provided do not count if they are:
Even if you're able to clear the first hurdle and avoid having your activity labeled by the IRS as a rental activity, you must still show that you materially participated in the aircraft leasing activity, in order to avoid the classification of your losses as passive. The IRS considers that you have materially participated in your aircraft leasing activity if you satisfy any one of the following tests:
While the tests listed above are designed to measure whether your participation is material, there are also guidelines published by the IRS defining participation. Generally, the regulations define participation as any work you (as a person with an interest in the aircraft) do with respect to the aircraft leasing activity. However, the IRS will not consider work that you do as participation if (1) it is not work that an aircraft owners would customarily do in a rental activity and (2) one of the main reasons that you are doing the work is to avoid the disallowance of any losses as passive.
You are permitted to establish proof of your participation by any reasonable means. While contemporaneous time reports and logs are not required, they can prove immensely helpful. The IRS permits approximations of time spent on an activity. But in the end, you are responsible for proving your participation meets the requirements of the regulations. At a minimum, you should have appointment books, calendars, electronic spreadsheets, or other reliable means to establish your participation.
While our experience indicates that very few, if any, of our members will meet the 500 hour test (See item 1), the substantial participation and 100 hour participation tests can be met. However, it is absolutely critical that you carefully document all the work you do for your aircraft leasing activity, in order to successfully assert your material participation.
Anyone considering leasing aircraft through an FBO or flight school should be aware of two Tax Court cases directly related to this issue. The legal citations for both cases are Frank v. Commissioner of Internal Revenue, T.C. Memo 1996-177 (1996) and Kelly v. Commissioner of Internal Revenue, T.C. Memo 2000-32 (2000). In both of these cases, the IRS took the position that the taxpayer's aircraft leasing activities were "rental" activities and therefore the losses incurred by the aircraft owners were passive in nature.
The IRS argued that the only "customer" of the aircraft owners was the FBO or flight school. Therefore, none of the exceptions to the general rule (see above) could apply. The Tax Court agreed with the IRS. To date, these are the only two published cases that address this issue. Both of these cases are now cited in IRS's Audit Technique Guide, the training and field manual used by auditors in the field. The message and import of these cases cannot be ignored or underestimated.
Another recent development is the release of IRS Revenue Procedure 2010-13. This ruling requires certain taxpayers to file special grouping elections disclosing the business relationships between an aircraft owner, aircraft operator, and any end users. One example of where this grouping will be helpful/necessary is the case of an aircraft owner dry leasing an aircraft that supports a business owned by the aircraft owner. Such an election may establish that the grouping is an "appropriate economic unit" or "single activity" for the purpose of determining gains or losses under the passive activity loss rules.
If you want to engage in aircraft leasing activities, you should be prepared with professionally drafted agreements and up-to-date information from lawyers and/or accountants familiar with the issues.
Questions and Answers about Income Taxes
Q. I want to put my leaseback aircraft into a corporation, and my accountant suggested that I use an S corporation. What is the difference between an S corporation and an ordinary corporation?
A. In an ordinary corporation (otherwise known as a C corporation), the net income of the corporation is subject to taxation at corporate tax rates. When any of this income is subsequently distributed to shareholders, the amount received by each shareholder is taxed as personal income at personal income tax rates. The result is a form of double taxation, with the income first being taxed at the corporate level at corporate tax rates and then at the shareholder level at personal tax rates.
In an effort to diminish the importance of the income tax as a factor in choosing a form of business organization, Congress amended the Internal Revenue Code to permit the formation of S corporations. Under the S corporation rules, certain small business corporations can elect to be taxed in a manner similar to that of partnerships. In other words, the corporation itself pays no income tax, but each shareholder's share of the corporation's income is taxed as personal income to that person, thus eliminating double taxation. Several requirements must be met for qualification as an S corporation, the most important of which are:
In general, the question as to whether to elect S corporation status will be governed by a number of factors, including the expectation of profits and current corporate and personal tax rates. This decision should be made carefully with the assistance of a tax professional. Nowadays, most aircraft owners tend to prefer the simplicity of a limited liability company (LLC) over the more cumbersome structure of an S corporation.
Q. When can I take a tax deduction for depreciation on my aircraft?
A. When you use your aircraft for business or income-producing purposes, the tax laws will allow you to recover the cost of the aircraft over a specified period of years, so that a portion of your aircraft cost is deducted each year. This tax deduction is known as depreciation. If you use your aircraft for personal purposes as well as business or income-producing reasons, you must allocate depreciation expenses to only that portion of the aircraft used for business or income-producing purposes.
Q. What methods are available for calculating depreciation on my aircraft?
A. There are essentially three ways to figure depreciation on your aircraft. The tax laws permit you to use MACRS (modified accelerated cost recovering system) if your aircraft was placed in service (put to use in business or to produce income) after 1986. If your aircraft was placed in service after 1980 but before 1987 you can use ACRS (accelerated cost recovery system). Both MACRS and ACRS are considered to be "accelerated" methods of depreciation because they provide you with larger depreciation deductions in the earlier years of your aircraft's life. If your aircraft was placed in service before 1981, you will probably be using a straight-line method of depreciation (or an alternate method such as the double-declining balance method).
"The American Taxpayer Relief Act” extends 50 percent bonus depreciation through tax year 2013. In some instances it extends bonus depreciation through 2014 (for designated transportation equipment). In order for new aircraft and equipment to qualify for bonus depreciation, they must be original or first-use aircraft (or equipment), used primarily for business purposes, and must also meet existing tests necessary to qualify for accelerated depreciation under MACRS (modified accelerated cost recovery system).
If your aircraft is not used predominantly (i.e., 50% or more) on an annual basis in your trade or business, the aircraft will be depreciable only under the straight line method mandated by what is called the ADS (alternate depreciation system) and is not eligible for bonus depreciation. The actual calculation of depreciation amounts is beyond the scope of this tax article. However, they are generally accomplished with the help of tables provided by the IRS. You should consult with a tax professional to ensure your calculations are correct.
Q. Over how many years will my aircraft be depreciated using current depreciation methods?
A. If your aircraft is used for business or income-producing purposes but is not used in commercial or contract carrying of passengers or freight, you can depreciate it over 5 years under MACRS and 6 years under the ADS. If your aircraft is used in commercial or contract carrying of passengers and freight by air, you will depreciate it over 7 years under MACRS and 12 years under the ADS.
Q. What are "Section 179" deductions?
A. Section 179 is an Internal Revenue Code provision that allows for an election to deduct or expense the cost of an aircraft. Under current law, if you purchase a new or used aircraft that is used in the active conduct of a trade of business, a special election may be made to take an immediate deduction of up to 100% of the first $500,000 of aircraft price for 2012 (and extended into 2013). This election is subject to a number of limitations, including a dollar-for-dollar reduction for an aircraft placed in service which costs in excess of $2,000,000 for 2012 (which means the maximum investment in a new or used aircraft would need to be less than $2,500,000 to be eligible for a Section 179 deduction). Importantly, the amount of any Section 179 deduction is further limited by the amount of taxable income from your aviation-related activity.
Q. How does depreciation affect my taxable income when I sell my airplane?
A. The IRS computes any taxable gains or losses on the sale of your aircraft by subtracting your aircraft's "adjusted basis" from the sales price. When you first purchase your aircraft, the adjusted basis will generally be the purchase price. However, the aircraft's adjusted basis will be reduced each year by the amount of depreciation you take as a deduction. Therefore, even if you sell your aircraft for the same price for which you purchased it, you may have to pay tax on a gain on sale to the extent you've depreciated the aircraft. This process is called depreciation recapture. For example, suppose that in 2009 you bought an aircraft that you use in your business. The purchase price of the aircraft was $50,000. In 2014 you sold the aircraft for $25,000 and had already taken $36,620 in depreciation.
You could compute your gain or loss as follows:
Sales Price: $25,000
Purchase Price: $50,000
Less Depreciation Taken: $36,620
Adjusted Basis: $13,380
Gain on Sale: $11,620
The $11,620 gain on this sale is due entirely to depreciation recapture and would be treated as ordinary income by the IRS. If the aircraft was sold for $60,000, the gain on the sale would now be $46,620 with the entire amount of depreciation, $36,620, recaptured as ordinary income and the remaining $10,000 being treated as capital gain income (Section 1231 gain).
You should also keep in mind that if you are exchanging your aircraft solely for another aircraft to be used in your trade or business, you may be able to defer any gain on your sale. The IRS rules on this type of nontaxable exchange are beyond the scope of this booklet and should be discussed with a tax professional.
Q. If I overhaul the engine(s) on my business aircraft this year, can I take a deduction for the full cost of the overhaul in this tax year?
A. In our opinion, the IRS will object to any attempt to deduct the full cost of your engine overhaul in this tax year. Although there is not any specific case law on this question, the IRS seems to have made it clear in Technical Advice Memorandum (TAM) 9618004 (May 3, 1996) that it will treat an aircraft engine overhaul as a capital expenditure. Generally speaking, a capital expenditure is an expense you incur in improving an asset which either increases the value of the asset or increases its useful life. In view of the IRS's published position in this matter, we would recommend treating your aircraft overhaul expense as a capital expenditure.
Q. Can I take a deduction for the aircraft expenses I've incurred while taking trips to inspect or repair my rental property?
A. Generally speaking, the answer to this question is "yes." The IRS allows a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year ... for the production of income or for the management, conservation, or maintenance of property held for the production of income." However, you should be aware that the IRS will carefully scrutinize this type of deduction. In one recent case, the IRS disallowed most of the expenses claimed by an aircraft owner on trips he took to a resort condo minimum that he owned and rented to others. The Tax Court agreed with the IRS and held that most of the trips were not deductible, because they were disguised family vacations. (See J.M. French 59 T.C.M. 966, Dec. 46,672(M), T.C. Memo. 1993-314).
Q. Can I take a deduction for a donation of my aircraft or my services as a pilot?
A. If you are contributing your aircraft to an organization recognized by the IRS as a charitable institution, you should generally be able to deduct the fair market value of the property (as measured on the date of the contribution) you donated. If you donate your services as a pilot, no deduction will be allowed for the value of your services. However, unreimbursed expenditures made as a result of your rendering services to a recognized charitable organization may constitute a charitable contribution. Therefore, oil and fuel expenses directly attributed to your flight could be deducted. Because of the limitations on this kind of donation when a pilot uses her own aircraft, tax professionals often suggest using rented aircraft for charitable flights when practical. This will allow for a full deduction of the out of pocket rental expenses.
Q. Will I gain any income tax benefit by transferring my aircraft to a living trust?
A. You will not gain any income tax benefit if you transfer your aircraft to a living trust. However, there may be other benefits that you should discuss with your estate planning counsel. One of these benefits may include the avoidance of the probate process. In order to make this work, you will have to make sure that you properly transfer your aircraft to the living or revocable trust. For general instructions on how to make the transfer, refer to AOPA's "How to Transfer an Aircraft Interest to a Living Trust."
Q. What happens if the IRS decides to examine my tax return?
A. If the IRS notifies you that your tax return is going to be examined, you should begin your preparation as early as possible. If possible, you should hire your accountant or attorney to represent you. All pertinent records regarding your aircraft-related deductions should be carefully reviewed and correlated to your tax return. In addition, you should be prepared to present the tax examiner with any pertinent case law which supports the position you've taken on your return. Sometimes, if you can't agree with the examiner, you may get an opportunity to discuss the case with the examiner's supervisors. If all attempts to settle the matter fail at this level of review, you will be issued a preliminary notice of the IRS's proposed changes to your tax liability.
Q. How can I dispute the IRS's findings in their preliminary notice?
A. If you do not agree with the IRS's findings, you can appeal to the IRS's Appeals Office. The Appeals Office is independent of the IRS District Director Offices, and many cases are settled at the appeals level. If you decide to take your case to the IRS Appeals Office, you will have to file a written request for an appeals conference. If the proposed change in your tax, including penalties, is more than $10,000, you will be required to submit a written protest. The appeals conference is informal, but you should bring along your representative, if possible. If you still can't settle your case after discussion with the IRS Appeals Office, the IRS will issue you a notice of deficiency, otherwise known as the "90-day letter." Within 90 days after receiving this notice you can either file a petition with the U.S. Tax Court or pay the tax and file a claim for a refund. If you decide to go to Tax Court and the amount in dispute is small enough (below $50,000), you may be able to take advantage of simplified procedures under the Tax Court's "small tax case procedures." These procedures allow for a less formal process in having your case heard. This could be very helpful if you do not have the money to pay for a representative. The only drawback to the small tax case procedures is that the decision of the Tax Court is final and can't be appealed. Under standard Tax Court procedures you could appeal your case to the U.S. Court of Appeals.
If you decide to pay the tax and file a claim for refund, you must wait at least six months for the IRS to act on your claim. If the IRS fails to act on your claim within six months or if your claim is denied, you may then file suit in the U.S. District Court or U.S. Claims Court. Decisions by either of these courts may be appealed to the U.S. Court of Appeals.
If you do wind up in a dispute with the IRS, we strongly suggest that you get a copy of IRS Publication 556 that is titled "Examination of Returns, Appeal Rights, and Claims for Refund." This publication has a wealth of information that you will need to understand the procedures involved in IRS disputes.
Q. Are there any tax consequences if my employer provides me an aircraft for personal use flights?
A. If your employer provides you with the use of an aircraft for non-business purposes, the value (or a portion) of the value of the flight may be includible in your income as a taxable fringe benefit. The rules regarding this issue are complex and require that you retain specialized tax counsel for assistance. However, suffice it to say that if we are talking about the use of light, general aviation aircraft, where no crew is provided by the employer, the fringe value benefit to you will be the fair market value of the transportation (e.g.-if the going rate for a Cessna 172 is $150 per hour, you will be deemed to be compensated at a rate of $150 per personal flight hour).
Part 2 – Sales and Use Tax
AOPA fields a lot of questions from members regarding sales and use taxes related to aircraft. The questions always take on a special urgency when the tax collector calls and wants to know why these taxes haven't been paid. Sales and use taxes can take a hefty bite out of your flying budget, and in most cases, they can't be avoided. But they can be planned for.
This guide is intended to acquaint you with the basics of sales and use tax laws. Any such attempt is fraught with difficulties because the laws change periodically and can vary widely from state to state, so for the most part, our discussion must be rather general.
There are, however, some common threads that run throughout the various state laws.
Our hope is that you will gain an awareness of potential problems and prepare for them when you plan your next aircraft purchase, or if you move your aircraft to another state.
If you have an option where you may buy an aircraft and where you may then base it, a careful examination of the specific state's tax laws might save you some money.
We've used two approaches to present the basic information. First, we'll discuss the nature of sales and use taxes, how they are collected, and some of the more common exemptions to the taxes. In the second part of this section, we'll answer some frequently asked questions relating to sales and use taxes.
The classic definition of a sales tax is a tax imposed on the sale of tangible personal property within a state. Most of us are quite familiar with the concept of a sales tax. We pay sales taxes on our smallest purchases up to our big-ticket items like cars, boats - and yes, aircraft. So if you buy an aircraft in a state that imposes a sales tax--and the vast majority do--you will be subject to the tax unless you qualify for an exemption. If you take the aircraft to another state, you may be faced with a use tax.
A use tax typically applies to the use, storage, or consumption of tangible personal property in a state. The wording of the laws indicates that a use tax could be imposed on everything that you might bring into a state. Although you may have brought whole truckloads of personal property into a state when you moved from one to another, you probably didn't have to deal with a use tax. Because of the tremendous problems in trying to police the payment of the tax, states choose to focus their efforts on big-ticket items, and an aircraft certainly is considered big-ticket.
To illustrate how the use tax works, let's say you buy an aircraft in State A, which has no sales tax. So far, so good - you don't owe any tax. You then move your aircraft to State B where it will be kept at a local airport that you use as a home base. If State B has a use tax, you will be liable for that tax unless you qualify for an exemption.
The use tax has a similar impact when you purchase an aircraft in a state that has a low sales tax rate. If State A imposes a 3-percent sales tax, which you paid, you are not off the hook if State B has a 5-percent use tax. State B should [see Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977)] credit you for the 3-percent tax you paid to State A and require you to pay the 2-percent difference between the tax rates.
As you can see, State B's use tax has the effect of negating the advantage of buying aircraft in a state with no sales tax or a low sales tax rate. In most states, the sales and use tax rates are the same, so your purchases of in-state and out-of-state goods will usually wind up taking the same tax bite.
Sometimes it isn't easy to determine whether your use of an aircraft in a particular state will trigger use tax liability. The law generally requires that your use of an aircraft creates a sufficient nexus or connection with the taxing state before use taxes can be imposed. In most cases, the state in which you base your aircraft is probably going to be able to assess you for a use tax. There is a case where the State of New York went so far as to try to impose use tax liability on an aircraft owner who was forced to make an emergency landing in that state. Thankfully, the state was unsuccessful in this attempt. It has also been ruled in several states that pilot training, routine maintenance, and warranty work will not trigger use tax liability. As a general rule, it is fair to say that, if your aircraft remains in a state for some extended period, the state may consider it part of your property in that state, and you may be subject to a use tax.
Once it is established that a sales or use tax is owed, the aircraft purchaser is normally responsible for payment of the tax. In some cases, a seller will be liable for collection of the sales tax, especially in cases where the seller is licensed to sell aircraft (i.e., an aircraft dealer). This does not, however, relieve the purchaser of the ultimate liability for sales or use taxes.
Usually the aircraft purchaser is responsible for obtaining the proper forms from the state in order to pay the appropriate sales or use tax. Often the tax is payable as of the date of the aircraft sale. Some states have requirements that the tax be submitted, along with proper documentation, within a specified number of days (typically 15 to 30 days) from the sale of an aircraft. Late payments are usually subject to interest and penalties.
How does a state track aircraft transactions? Some states require that you register your aircraft. This is an easy way for them to track the ownership of an aircraft. Other states regularly obtain information from the FAA regarding aircraft newly registered by residents. Sometimes it is as simple as sending a tax collector out on the airport ramp to record N numbers or review control tower log sheets, so they can later be cross-checked with state tax records. You should be aware that states have become more and more aggressive in collecting sales and use taxes on aircraft. Many state budget deficits are growing, and aircraft are an easy target for tax collectors.
As you can see, it is difficult to escape sales and use taxes; however, there are exemptions scattered throughout the states that might offer some relief in specific cases. Some states provide relief to aircraft owners by taxing aircraft at a lower than standard rate or by placing a limit or cap on how much the tax can be.
One limited exemption allows you to avoid the sales tax in the state where you purchased an aircraft if you take delivery of it out of state or intend to ship it out of the state within a specified time frame. This exemption is often referred to as a "fly-away" exemption.
However, as you recall, this exemption will not be helpful if you bring the aircraft into a state that has a use tax. Some states permit an exemption for "casual, isolated, or occasional sales." What constitutes a casual, isolated, or occasional sale is not always easy to determine and isn't the same in all states. Certainly, a sale by a person regularly engaged in the business of selling aircraft is not casual, isolated, or occasional. But a sale from a private owner who used the aircraft for his own business or pleasure would be considered casual, isolated, or occasional. There can be many factual variations, and each one must be looked at in the light of applicable state law. While the casual sales exemption seems attractive at first glance, a closer look shows that its usefulness has diminished over the years. For instance, some states that have a general exemption for casual, isolated, or occasional sales specifically exclude sales of aircraft. In other states, the exemption only applies to sales under $1,000 or some other low dollar amount. So before you jump to the conclusion that you are exempt because you purchased an aircraft through a private seller, you ought to check the applicable state laws very carefully.
Another exemption worth mentioning is what we will call the interstate commerce exemption. This exemption is specifically carved out in some states for aircraft, motor vehicles, railroad cars, etc., that are used principally in interstate or foreign commerce. So if you purchase an aircraft that you use regularly across state lines for business, this exemption might be applicable. This exemption applies regularly to situations where an aircraft will be used for commercial operations in a Part 135 or Part 121 operation.
If you are going to purchase your aircraft with the intention of leasing it to a flight school or FBO, you may qualify for a full exemption from sales tax. Many states consider leases to be "sales." That means that if you purchase your aircraft for the purpose of leasing it to others, you are purchasing the aircraft for the purpose of resale-a common exemption from sales tax. However, once you start collecting money for the leased aircraft, you will typically need to pay sales tax on the lease revenue received. Taking advantage of this exemption often requires pre-registration for a resale certificate or license and careful planning by tax professionals.
Now that we've gone over the basics, let's take a look at some specific questions we frequently get from members relating to sales and use taxes.
Questions Relating to Sales and Use Taxes
Q. Don't all sellers automatically add sales or use tax to the purchase price of an aircraft?
A. No. Just about the only time you will pay a sales tax at the point of purchase is when you buy from someone in the business of selling aircraft in a state that has a sales tax and there is no exemption from it. If you buy from a private owner (one of the casual sales we discussed), he/she probably won't be familiar with the sales tax law, and you are better off settling the matter directly with the appropriate state office. The seller is rarely involved with the "use" part of the sales and use tax. If you buy an aircraft in one of the few states that has no sales taxes, the seller won't collect the use tax for another state where you may intend to base the aircraft. The same is true if the state where the purchase is made has a sales and use tax, but you qualify for the exemption because the aircraft will be based in another state. Occasionally, an aircraft dealer that does business in another state might collect the use tax for that state at the time of purchase.
Q. How do I report an out-of-state purchase?
A. Generally, you have to call or write to the appropriate state officials who will provide the necessary reporting forms. When the state finds out independently that you have an aircraft based in the state, and the sales and use tax hasn't been paid, the state will contact you.
Q. Do I have to pay taxes on used aircraft I bring into another state for storage or use?
A. Generally, yes. However, some states will allow you to claim a certain amount of depreciation for each full year you used the property before bringing it into the taxing state. For example, let's say you buy an aircraft in Delaware for $100,000 and have it based there for four and a half years. You didn't pay a sales tax to Delaware because Delaware has none. However, you later move to Maryland and the tax collector in Maryland wants to assess a use tax of 6 percent. Under Maryland law, you will be allowed to take a depreciation deduction of 10 percent for each full year the aircraft was used outside Maryland. This will reduce the tax base of your aircraft to $60,000 ($100,000 purchase price less four full years of depreciation at 10 percent). So instead of paying a use tax of $6,000 (6 percent of $100,000), you will pay a use tax of $3,600 (6 percent of $60,000). Some states (i.e. Florida) may also provide for an exemption from use tax if your aircraft was based and used outside the state for a certain period of time (in the case of Florida, 6 months).
Q. If I purchased an aircraft and received credit for the trade-in of my old aircraft, do I pay sales tax based on the value of the purchased aircraft or the cash I paid to the seller?
A. Most sales and use tax laws expressly provide for the inclusion of amounts credited on a trade-in when calculating the taxable purchase price of an aircraft or other item of personal property. This is generally the rule in the absence of an express provision.
Q. Can military personnel get an exemption from sales and use tax through the Soldiers and Sailors Relief Act?
A. No. Our reading of the act leads us to the conclusion that it doesn't prohibit states from imposing a sales or use tax on servicemen.
Q. If I own an aircraft as an individual and decide to transfer it to a partnership or newly formed corporation, does the partnership or corporation have to pay a sales or use tax on the transfer?
A. Before paying any taxes on a transfer like this, you should carefully review the applicable state laws. Some states specifically exempt transfers of personal property, such as aircraft, to a partnership or newly formed corporation.
Q. What can I do if the state comes after me for sales or use tax, and I don't believe I should have to pay?
A. All states provide you with appeal rights. Your first appeal of an assessment will probably be before the state agency that assessed the tax. If you're not satisfied with the results of the agency appeal, you may have to go to a state tax court (if available) or to a general trial court in your state.
Q. If a state collects a sales or use tax on my aircraft, can they also collect personal property taxes?
A. Yes. The personal property tax is a separate tax that many state or local governments impose (usually on an annual basis) on property located within their jurisdiction. So even if you're fortunate enough to have paid little or no sales or use taxes, you may still be faced with a personal property tax.
Q. Is there any limit to how far back in time a state can go to collect a sales or use tax?
A. Yes. Most states have a statute of limitations that requires that any sale or use taxes be collected within a specified period of time from the date the tax would be due (usually five to 10 years).
A final note - if you have any questions regarding the application of sales and use taxes to your aircraft purchase, consult with an accountant or attorney familiar with the appropriate state and local rules.
State Sales Tax Divisions: Points of Contact - Sales/Use and Excise
Due to the rapidly changing state and local tax codes, we have not published tax rate data. Specific information can be obtained by contacting the appropriate state agency.
Dist. Of Columbia
Part 3 – Personal Property Taxes
Another type of tax you may encounter as an aircraft owner is a personal property tax. The following states have personal property taxes that may apply to your aircraft:
Alabama, Arkansas, California, Georgia, Kansas, Kentucky, Louisiana, Minnesota, Missouri, Nebraska, Nevada, North Carolina, Oregon, South Carolina, Tennessee, Texas, Utah, Virginia, West Virginia, Wyoming.
Please note that in several of these states, personal property taxes are applied at the local level.
Generally speaking, personal property taxes are assessed on all property of (1) a specified type; (2) located within a certain place; and (3) at a specified time. A brief discussion of these features of personal property taxes, as they relate to your aircraft, follows below.
Property of a specified type. There is little doubt that your aircraft is a tempting target for any state or local tax collector. First, it is easy to trace the existence of your aircraft through FAA or local registration documentation. Second, your aircraft usually represents a relatively high dollar assessment as far as personal property taxes go. Although your aircraft may be an easy target for personal property taxes, you should be aware that many jurisdictions only assess you if your aircraft is used for commercial or business purposes. Therefore, if your aircraft use is purely personal, you should check to see if you are exempt from the tax before you pay.
Located within a certain place. It is well settled that with respect to aircraft and other tangible personal property, the actual site of your aircraft, rather than your residence, determines the place of taxation. Therefore, if you live in a jurisdiction with no personal property tax, you may still have to pay tax on your aircraft if you base it within a taxing jurisdiction. The legal rationale for this rule is based on the theory that your aircraft is enjoying the protection of the state or local jurisdiction where it is kept. Therefore, when you're planning on a place to base your aircraft, you may want to consider whether that place has a personal property tax. You can't simply go by the law where you happen to have a residence at a specified time.
This is an interesting feature of personal property taxes. The tax is often based on property found within the taxing jurisdiction at a certain date. Some aircraft owners have interpreted this to mean that as long as their aircraft is out of the state on the specified "tax date," they are not subject to tax. It's not that easy. The law generally states that as long as your aircraft has a more or less permanent location within the taxing jurisdiction, you can be subject to personal property taxes. Of course, this also means that if you are merely passing through or have your aircraft at a site for repairs on the tax date, you should not be subject to personal property taxes.
You should keep in mind that many states have personal property tax laws that permit local jurisdictions (counties or cities) to levy personal property taxes. Your local jurisdiction may or may not levy personal property taxes.
Another important point to remember is that the personal property tax is based on the value of your aircraft. Most states apply the tax on the fair market value of the aircraft. Therefore, you should ensure that the assessed value of your aircraft for tax purposes coincides with published guidance.
Some states also have registration fees that they impose on aircraft. Sometimes the fees are in addition to personal property taxes (see Oregon, Utah, and Virginia) and sometimes they are substitutes for personal property taxes. The states imposing registration fees are listed below:
South Dakota Utah
Registration fees are often imposed as a flat rate. However, sometimes the fee is dependent on the weight and/or seating capacity of the aircraft. You should check with your state or local revenue office to determine the method applied.
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