By Ray Speciale
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 information 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 which 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 for important cases and rulings for you and your tax advisor to review.
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, 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 bigger 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 p. 4, 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.
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 probably 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. You should 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 self-employed, 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).
Marshall v. Commissioner of Internal Revenue, T.C. Memo 1992-65
Marshall was a Lieutenant Colonel in the United States Air Force (Air Force). He was assigned to a special project that required travel, and he used his Piper Twin Comanche for certain work-related trips. The Air Force reimbursed Marshall for a portion of his aircraft expenses on these trips. However, a substantial portion of his aircraft expenses were not reimbursed, so he claimed the unreimbursed portion of his total expenses as a deduction on his 1984, 1985, and 1986 tax returns. The IRS challenged these deductions, claiming that Marshall's aircraft expenses were not "ordinary or necessary" under the Internal Revenue Code.
In reviewing this case, the Tax Court first found that Marshall's aircraft expenses were "necessary" because they were appropriate and helpful to his conducting Air Force duties. The court recognized the direct access to destinations allowed by his aircraft which permitted him to save time on travel and increase productivity. It was also noted that the Air Force acknowledged that "[travel] by privately owned aircraft has been determined as more advantageous to the government."
The court also found that Marshall's travel expenses were "ordinary." The court stated that "[i]n this day and age, there is no doubt that the use of private air-planes by executives in charge of large projects is a common practice." Finally, the court determined that besides being "ordinary and necessary," Marshall's aircraft expenses were also "reasonable." In drawing this conclusion, depreciation deductions, although allowable, were not considered for the purpose of analyzing the reasonableness of his deduction for aircraft expenses.
Noyce v. Commissioner of Internal Revenue, 97 T.C. No. 46 (1991)
Noyce was vice chairman of Intel Corporation. His position required frequent and extensive travel. Noyce purchased a Cessna Citation in order to help him meet his demanding travel schedule. The aircraft helped him increase the number of meetings he could attend on behalf of his employer. However, pursuant to Intel's policies, Noyce's travel was reimbursable only to the extent of commercial airline coach rates. Also, as a matter of corporate policy, Intel officers were expected to bear certain travel expenses without reimbursement. In 1983, Noyce claimed $139,369 in deductions for the unreimbursed expense of operating the Cessna Citation. Of this amount, $112,463 was depreciation expense. The IRS disallowed Noyce's aircraft deductions in total.
Noyce petitioned the U.S. Tax Court to review his case. The court first ruled that Noyce's use of the Cessna Citation in the course of his employment for Intel was a part of his "trade or business" of being a corporate official. The court went on to rule that Noyce's aircraft expenses were "ordinary and necessary" because the aircraft clearly allowed Noyce to travel on a more flexible and productive schedule. Significantly, this case also marks the first time that the Tax Court clearly states that when determining whether expenses are reasonable in amount, the amount of expenses considered does not include amounts deducted for depreciation.
Sartor v. Commissioner of Internal Revenue, T.C. Memo 1984-274
Sartor serviced a sales territory including Utah; Idaho; Colorado; Washington; Oregon; Montana; and Vancouver, Canada. He used a private aircraft to travel on customer visits throughout his wide sales territory and deducted his associated aircraft expenses on his income tax return for 1980. Although his company did not reimburse him for all of his aircraft expenses, they did pay him what it would have cost him to fly commercially.
In ruling in favor of Sartor's tax deductions for aircraft expenses, the court stated: "We find that the travel expenses were very helpful to petitioner in his business of being a salesman. The record shows that petitioner was given a large sales territory with customers located several hours from major airports. Due to the deregulation of the airlines, there were less frequent flights to the petitioner's sales areas and alternate methods of transportation were inadequate and time consuming. By using the airplane, petitioner was able to arrange a more flexible schedule [that] enabled him to maximize his sales opportunities. Under these circumstances, we think it is clear that petitioner's additional travel expenses incurred by using the airplane were appropriate and helpful in his business as a salesman. Thus we conclude that the travel expenses were necessary within the meaning of section 162."
Sherman v. Commissioner of Internal Revenue, T.C. Memo 1982-582
Sherman was employed as a salesman covering a six-state sales territory. He used his personal aircraft to service his customers, and in 1976 he claimed deductions for aircraft operating expenses totaling $17,787. The IRS claimed that Sherman's aircraft expenses should not be deductible, because they were not ordinary and necessary employee business expenses.
The Tax Court held in favor of Sherman and confirmed that his aircraft expenses were ordinary and necessary employee business expenses. The court was particularly impressed with the fact that since only 2 of the 24 airports Sherman frequented were serviced by commercial flights, he had no practical alternative other than to use his private aircraft.
Knudtson v. Commissioner of Internal Revenue, T.C. Memo 1980-455
Knudtson owned and operated a business which rebuilt automobile windshield wiper motors. In operating his business, it was important that Knudtson maintain a close association with his suppliers, who were located throughout the United States. In order to meet his extensive travel demands, Knudtson purchased a 1975 A-36 Beech Bonanza. The IRS disallowed aircraft expense deductions taken by Knudtson for 1975 and 1976, and Knudtson petitioned the Tax Court.
In supporting Knudtson's position, the Court said that it was clear that the cost of owning and operating the Bonanza was an ordinary and necessary expense of Knudtson's business. The court focused on the fact that Knudtson's suppliers and customers were located throughout a large geographic area and Knudtson had to maintain a close working relationship with suppliers. Therefore, the court said that Knudtson aptly described his airplane as a business tool. The aircraft expenses were necessary in the sense that they were appropriate and helpful to the development of his business. The expenses were also deemed ordinary as a normal and rational response to specific business conditions under which Knudtson operated.
Rev. Rul. 70-558
A federal employee who traveled extensively for work-related purposes was authorized to travel by "private owned auto or aircraft," among other possible means of transportation. This employee was reimbursed for his travel at a standard rate based on miles traveled. However, the employee was able to properly substantiate all his aircraft operation expenses in excess of reimbursement.
After considering these facts, the IRS ruled that the employee's expenses in excess of his reimbursements were deductible as ordinary and necessary business expenses. The IRS also ruled that deductible expenses included depreciation to the extent it is properly allocated to business use of the aircraft.