Choices for Aircraft Ownership
Partnership, corporation, limited liability company or sole proprietorship?
The purpose of this article is not to advise prospective owners about which entity suits their particular needs because individual circumstances dictate which entity is the right one. Instead, we'll explain the differences between sole proprietorships, general partnerships, limited partnerships, S corporations, C corporations, and limited liability companies. we'll assume the owners will use the aircraft for some type of business activity or investment because the tax benefits and liability protections generally apply to businesses only. Prospective owners should talk with their CPA or attorney who can then assist them in choosing the proper vehicle for ownership.
The differences between the various ownership entities center around two main issues - tax consequences and personal liability protection. These differences and how they apply to individual circumstances make it important to choose the proper one. One entity may give good liability protection and bad tax consequences, another may have excellent tax advantages but no liability protection. Some of the entities may have beneficial tax advantages as well as liability protection, but still not be an adequate choice because of poor flexibility. The best advice is to seek knowledgeable advice. Here's a summary of each entity.
Sole proprietorships
This entity is exactly what it says - one person operating a business as an individual - something like "Steve Arthur d/b/a Professional Pilot Training."
No great tax consequences accrue to operating as a sole proprietor, except that the proprietor must complete Schedule C, "Profit or Loss from a Business," of IRS Form 1040, and that the ordinary and necessary reasonable expenses incurred in operating the proprietorship are deductible against the income earned.
If your net income for the year is a loss, that loss is deductible against other income, such as wage income, capital gains, and interest listed on the first page of IRS Form 1040, which determines gross taxable income. However, if a sole proprietorship operates at a loss for more than three years, the IRS may consider it to be a hobby, not a true business, and might disallow certain deductions.
Sole proprietorships don't give the proprietor any personal liability protection. if an accident or injury to another person occurs during the course of business and the proprietor is found to be at fault, he is personally liable. This means all of the proprietor's personal assets (house, car, aircraft, savings) are vulnerable. Even if the proprietor has some type of liability insurance, the proprietor is on the hook for any remainder if the coverage is less than the damages awarded. By far, sole proprietorships are the easiest way to conduct business (fewer forms, little administrative burden), but people often shun them because they lack personal liability protection.
Partnerships
General and limited partnerships are like sole proprietorships, but more than one individual is involved in the business. Partnerships must be organized to carry on a business, financial operation, or venture. They have "flow-through" tax consequences, which means the partnership is not taxed as an individual entity (even though the partnership must file a separate tax return). The partnership's income and deductions are passed through to the partners in certain proportions, like the sole proprietorship. Partnership taxation is exceptionally complex and is best left to CPAs, but it's adequate to say that "flow-through" taxation is an advantage for most taxpayers rather than a disadvantage.
The downside to a partnership is the lack of personal liability protection. every person in a general partnership risks personal liability for the debts and damages of the partnership. Limited partnerships, however, provide some measure of liability protection for their "limited partners."
In a limited partnership, only the "general partners" are exposed to personal liability, but they also get to "run" the partnership. Limited partners, who have some liability exposure, are prohibited from participating in the management of the partnership's affairs. Limited partnerships are more complicated than general partnerships, and they carry additional administrative burdens such as state registration.
If several individuals simply get together and purchase an aircraft to use as a business without doing anything more, they would have a partnership with flow-through tax consequences and the burden of no liability protection. If several individuals get together to purchase an aircraft for fun and not a business, they would have co-ownership of an aircraft, not a partnership. Many people (and attorneys) refer to co-ownership as a "partnership," so the owners need to be careful about which box they check on FAA Form 8050-1 - Aircraft Registration.
S Corporations
S Corporations, it seems, are becoming a thing of the past, slowly being replaced by the LLC, but they retain merit for some aircraft owners. S Corporations have flow-through tax consequences, but because they are a true corporate entity, they also give their shareholders personal liability protection. They are limited to 75 shareholders who generally must be domestic individuals, and one-person S Corporations are common. Shareholders must apply to the IRS for S Corporation status and the entity must file an annual tax return.
S Corporations give shareholders liability protection through a "corporate veil," but the simple existence of a corporation - that is, filing Articles of Incorporation with the state - does not provide liability protection. The S Corporation must carry on a business, keep records, and follow the formalities of how a business is run. If the company exists as a shell only, the corporate veil will be "pierced" and personal liability for the debts of and the injuries caused by the corporation will attach to the individual shareholders.
C Corporations
C Corporations have no limit on the number or type of shareholders, and they give shareholders personal liability protection against the acts and debts of the corporation. they do not have flow-through tax consequences. Instead, a C Corporation has two layers of taxation, which is known as "double taxation." The IRS taxes its earnings, and then, after the C Corporation distributes those earnings to shareholders as dividends, the shareholders must pay a tax on those dividends. In addition, the C Corporation cannot take a deduction for the dividends it distributes. For this reason, a C Corporation is often not the preferred entity for many businesses.
Limited Liability Companies
LLCs got their start in this country during the 1970s in Wyoming. Later, other states drafted statutes recognizing LLCs, and now every state in the nation has a Limited Liability Company statute. LLCs seem to combine the best of all worlds. They do not have partners or shareholders, but they have members who own membership interests.
LLCs give their members personal liability protection for the company's wrongs and debts, and they have flow-through tax advantages. They are not subject to double taxation, unless the LLC elects to be taxed as a corporation. LLCs must also be formed to carry on a business, but they don't have the limitations and restrictions that S Corporations have.
LLCs seem to be a nice fit for aviation businesses because they have some additional partnership-type tax "tricks" that are helpful for heavy assets like aircraft. LLCs allow disproportionate allocations of income and loss to members, and allow appreciated property to be distributed to members without a tax on the gain. Members can also contribute appreciated property for membership interests and also not be taxed on any gain. again, this is the domain of CPAs.
LLCs are generally more flexible and don't have the administrative burdens of the other entities. But the members must operate them like a business and must follow business formalities to the letter. An attorney can take care of the necessary paperwork to establish your LLC.
Some states have other less common business entities such as Limited Liability Partnerships and Limited Liability Limited Partnerships, but these entities are useful for rather narrow functions and are generally not well suited to aviation enterprises.
When you think about buying an aircraft, the main thing to keep in mind is that the simple act of setting up some kind of formal business entity for the purpose of owning the aircraft probably will not provide the kind of benefits widely assumed. The devil is in the details, and some sort of business or investment purpose must exist before the benefits apply. A quick visit to an accountant or business planning attorney can save you many headaches later on.
