United States: Company Jet Audit Issues: A Word To The Wise

Once a business attains a certain level of success, an aircraft often becomes a valued asset.  Public and closely held private companies alike find that the use of a private aircraft—whether possessed via whole or fractional shares, and whether owned, leased or chartered—fosters secure and efficient transportation for owners and executives.  However, this benefit does not come without a price, and it is not unusual for the tax deductions with respect to the typical flight department to run in the $20 to $30 million range.  These significant amounts, and the fact that the deduction and other tax rules are so complex and often subjective, have caused company aircraft to catch the attention of the Internal Revenue Service (IRS).  A new Information Document Request (IDR), IRS Form 4564, has recently been employed on audits of companies with business aircraft, providing a roadmap for how to prepare for an IRS audit.


In order for a business to deduct substantial aircraft-related costs, several complicated tax issues must be vetted, including: (1) the proper depreciation schedule for the aircraft and equipment; (2) the new Internal Revenue Code (Code) Section 274 entertainment disallowance rules; and (3) the passive activity rules.  Any actual or deemed payments for use of the plane also may be subject to a 7.5 percent excise tax.  Finally, the executives flying may have more imputed income for flights not properly documented as being primarily in the interests of the business rather than an individual benefit.  The new IDR requests information that would allow the IRS to determine whether these tax requirements are satisfied.

The Business Deduction

In preparing the business tax return, taxpayers historically simply deducted all the expenses of the business aircraft on the basis that the aircraft was used within the scope of the company's business and thus met the deduction rules of Code Section 162.  However, since October 22, 2004, there has been a "take away" from that deduction under Code Section 274 for any use that is considered personal "entertainment, amusement, or recreation."  Unfortunately, many businesses are unaware of this rule, or if they are aware of it, they do not follow the now-final Treasury Regulations promulgated pursuant to Code Section 274 regarding how to properly calculate the "take away."

In short, under these rules, if a business has $20 million of aircraft expenses, and 25 percent of the aircraft usage was for personal entertainment travel, $5 million of the expenses are not deductible on the business tax return.

The IRS is aware of some easy adjustments vis-à-vis the Code Section 274 deduction disallowance that applies to virtually all companies owning aircraft.  The new IDR asks for the Code Section 274 calculation performed by the company.  The IDR separately asks for the total expenses of the aircraft, including the following:

  • Catering fees
  • Depreciation
  • Interest expense
  • Lease payments
  • Charter payments
  • Management fees
  • Other costs
  • Crew and maintenance salaries
  • Crew meal and lodging expenses
  • Takeoff and landing fees
  • Maintenance flights
  • Hanger fees
  • Fuel
  • Tires
  • Insurance
  • Registration  

The IDR also asks for all information that would be on the flight logs, and requires the name of each passenger and specification of whether each passenger was travelling for business, personal reasons or personal entertainment.

On audit, the IRS is making significant adjustments based on the information obtained in response to the IDR for a variety of reasons, including that the business was not able to show it did the Code Section 274 calculations, or did them incorrectly, or did not substantiate the specific use by each passenger.


The cost of purchasing an aircraft can be taken as a tax deduction surprisingly rapidly, typically over five years.  Although the Obama administration raised the specter of lengthening the period for depreciation, at the same time it enacted "bonus" depreciation that allowed for 50 percent to 100 percent of the entire cost deduction to be taken in the year a new aircraft is placed in service, rather than in later years over the normal five-year period.

A threshold test for using bonus depreciation for closely held companies is satisfying Code Section 280F, which requires a complicated two-step 25 percent and a 50 percent business use test in order to qualify.  Code Section 280F is a "when," not a "how much," test and is often misinterpreted by taxpayers.  The IRS is taking a hardline approach where an aircraft is leased to a related company, arguing that even business use by an owner will not allow the Code Section 280F test to be satisfied, commonly referred to as the "leasing company trap."  See IRS Tech. Adv. Mem. 200945037.

On an alternative basis, bonus depreciation in the amount of $11.25 million for an aircraft purchased and actually flown in 2003 was attacked by the IRS in the recent case of Brown v. Commissioner, T.C. Memo. 2013-275.  There, the issue was that the aircraft was not being placed in service in 2003 for the specific purpose intended, when the taxpayer indicated that a conference table and big screen TV were integral to his specific intended business use.  In response to the taxpayer's substantiation of the business use, the Tax Court stated, "this is just not believable" and assessed a 20 percent understatement penalty pursuant to Code Section 6662.  Of interest in the case is the Tax Court's reference to Ernest Hemingway's reply to F. Scott Fitzgerald: "the very rich are different from you and me . . . [T]hey have more money."  This statement is indicative of the general attitude of the IRS and the courts with respect to audits of aircraft.

Passive Activity

Passive activities as defined in Code Section 469 are endeavors with insufficient "material participation" conducted by an individual or by flow-through businesses, such as subchapter S corporations or partnerships, and are generally not of concern in the C corporation context.  The problem with passive activity historically was that passive activity losses could only be offset by passive activity income, and therefore passive activity income itself was not in any way a problem.  However, the interest in avoiding passive activity characterization has increased with the new Code Section 1411 that applies a 3.8 percent tax to "net investment income" generated from passive activities. 

The typical context in which passive activity issues arise is where an aircraft is held in one entity and leased to a second entity.  Leasing is per se a passive activity.  Note that passive activity leasing refers to a so-called "dry lease" of the aircraft (that is, without a pilot), not the "wet lease" or charter that refers to use of the aircraft with a pilot provided by the lessor.

There is a solution around the application of the passive activity rules where an aircraft is dry leased and used by a second business that is related to the lessor business.  To avoid the passive activity rules, the taxpayer can do a passive activity grouping election before the auditor comes knocking.  The mechanics of the election are provided by Revenue Procedure 2010-13, 2010-1 C.B. 349, and the timeframe to make the election has been extended at a minimum through 2014.

Federal Excise Tax

Just as many businesses that own aircraft are not aware of the new entertainment deduction disallowance, many also are unaware of the Federal Excise Tax imposed by Code Section 4261 that can apply to payments received or deemed to be received for use of their piloted aircraft, even where the aircraft operates under Part 91, the Federal Aviation Administration authority for non-commercial use.  It is simplest to think of this tax as a type of sales tax.  Code Section 4261(a) imposes a 7.5 percent tax, plus a small leg tax, on the amount paid for taxable transportation that begins and ends in the United States.  Therefore, if a U.S. business accepts a cash reimbursement for domestic travel on its "corporate jet," it may be obligated to collect and pay over the excise tax, a tax normally associated only with commercial air travel. 

There has been a tremendous amount of audit activity related to this little-known excise tax.  For example, the battle over the Federal Excise Tax as applied to fractional ownership resulted in congressional action to change the rules.  Where a taxpayer owned a partial interest (referred to as a "fractional" share in the world of air travel) and a company provided management services, the IRS's position was that the taxpayer was actually leasing the aircraft to the management company, which then chartered the aircraft.  In effect, the IRS claimed that the owner was chartering its own aircraft to itself and owed the 7.5 percent excise tax on those payments.  Billions of dollars were involved, and Code Section 4261 was amended to exempt fractional interests.  To make up the tax gap, Congress increased the fuel tax.

After the fractional interest debacle, the IRS did not give up.  In virtually all audits of aircraft across the United States, the excise tax was asserted in instances where the taxpayer owned its own whole aircraft but, instead of having a flight department and its own pilots, employed a commercial aircraft management company to provide those services.  On April 19, 2013, the National Business Aviation Association (NBAA) referenced prior favorable guidance on the issue, stating the following in a letter to the IRS:

Finally, the Chief Counsel Advice (CCA) memorandum (Number: 201210026, released March 9, 2012) ignored this conflicting guidance and took the approach that virtually all amounts paid by an aircraft owner to a management company are subject to FET.  Since the publication of the CCA, NBAA and NATA have observed that virtually any business aviation company engaged in providing aircraft management services is subject to audit.  The expense incurred by the Service to undertake these audits, and by the taxpayer to defend the audits, is significant and clearly not the best use of resources by either party.

Code Section 4282(a) provides that the tax imposed does not apply to amounts paid by one member of an affiliated group to another member of that group for air transportation.  In Private Letter Ruling 200123002 (January 2, 2001), the IRS declared that the exemption did not apply where the group members were not corporations.  Thus, where an affiliated group of companies share an aircraft, the Code Section 4261 7.5 percent tax will apply on the fair market value of the aircraft use even where a cash payment is not made, unless the usage is corporation to corporation.

The new IDR seeks information pertaining to any payments made for use of the aircraft by individuals.  The IRS is seeking ammunition to apply the excise tax to reimbursements made by executives, typically in public company situations where the executive reimburses so as not to have the value reported on the proxy statement, e.g., PLR 200705010 (the IRS ruled that where a former CEO reimbursed the employer for use of the aircraft, the employer was obligated to collect the Code Section 4261 excise tax from the CEO).

Imputed Income

It is safe to say that everyone wants to avoid "imputed income," which refers to a situation where the taxpayer did not actually receive cash, but his tax return must show income expressed in dollars for the accretion in wealth he was deemed to experience.  Usage of company aircraft is rife with imputed income opportunities that employment tax auditors eagerly pursue.  Owners of partnerships receive imputed income as a guaranteed payment on their Form K-1.  Independent contractors, such as directors, will see it on the Form 1099, and employees, including Subchapter S owners, will receive it on their Form W-2 subject to typical employment tax withholdings.

A flight that is primarily for the business of the entity providing the aircraft will not result in imputed income.  This would seem to be an easy determination, but it is not.  In Flowers v. Commissioner, 326 U.S. 465 (1946), the Supreme Court of the United States held that the taxpayer must be away from the tax home to deduct travel expenses.  The "tax home" must be identified and has nothing to do with state tax residency, but is a federal income tax determination of the location where the individual performs most of his work, makes most of his money, and where the most important work is performed, based on all the facts and circumstances.  This determination is becoming more difficult with the advent of telecommuting and the fact that the sophisticated executive may not spend the bulk of his time in any one location.  The concept of a tax home is still developing, and the IRS challenges it frequently on audit.  The determination of tax home was favorably decided, for example, in Snellman v. Commissioner, T.C. Summ. Op. 2014-10; No. 13186 125.  In that case, an unemployed individual living in Florida obtained a job in Missouri for less than one year, and the Tax Court determined that all his travel, lodging and meals in the job location were excluded from income as travel away from home.

The general rule for imputed income for personal travel is to refer to the arms-length charter rate for the same flight, but the regulations under Treasury Regulations Section 1.61-21(g) allow for use of the Standard Industrial Fare Level (SIFL) rates, which are only approximately $1 per mile for the highest paid employees, officers and owners.  If an auditor catches the taxpayer not imputing income for a flight that the auditor determines is personal, the far higher charter rate amount will be used.

In addition to commuting trips that do not start from the tax home, the IRS examines two other areas: spousal travel and business entertainment.  In short, gone are the days when the cost to bring a spouse along on a business trip qualified as a deductible ordinary and necessary business expense.  Not only will the IRS impute income for the "tag-along" spouse, there is a very real danger that the spouse's presence will cause the entire trip to be viewed as personal rather than business, resulting in imputed income for the employed spouse as well. 

Business entertainment is a favorite for the IRS auditor to reverse treatment, impute income, and impose penalties and interest.  Unless the entertainment is in a clear business setting, such as a gala to celebrate an office opening, the entertainment must be associated with or directly related to the active conduct of the taxpayer's business.  Generally, this means that the taxpayer and its potential customers or clients cannot simply enjoy one another's company while engaging in an entertainment activity, such as golf, skiing, fishing, dining or sightseeing.  Rather, there must be actual business conducted that can be substantiated by focused and documented business discussions of specific, not general, topics, recorded for later IRS review.


The IRS has refined its audits of business-owned aircraft and is expressing tenacity in getting the maximum federal tax dollars from miscalculated tax deductions, incorrect imputed income and nonpayment of excise tax.  Companies that own aircraft should know the rules and document, document, document.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions