This year has produced quite a few tax law changes that will impact general aviation and the business use of aircraft. There are extremely favorable depreciation deductions with bonus depreciation rules, and for selected new aircraft purchases, this could possibly carry over to 2013 to allow time to complete the purchase. The 2012 Section 179 depreciation rules are very favorable, but they're likely to lose a lot of their benefits in 2013. There are two issues that will affect your tax situation, along with an old and frequently asked question by those who are new to aviation. You'd also be surprised how often this same question—the tax deductibility of flying lessons—is posed by long-time pilots who want to add to their ratings.
Capitalization Versus Repair
The IRS issued a new set of "temporary" regulations as of January 1, 2012. For the record—while these are "temporary" regulations, they carry the full weight of the law and must be complied with until they're withdrawn or made permanent. They count! While the intent of the new regulations was to simplify and coordinate the application of the tax law with the court decisions that have been handed down over the last 10 or so years, as we're becoming more familiar with the 160 pages of regulations, we're finding more new questions than answers to old questions. In order to comply with the regulations, you may even have to apply to the IRS for permission to change your method of accounting. So much for simplification.
If you're in the market for purchasing an aircraft (especially a used one that you're planning to make modifications and improvements to), a firsthand knowledge of the new regulations may save you from an unplanned tax result. This could be the case where a buyer and seller are negotiating the sale and the point of the annual inspection or TBO comes up. Being aware of the new regulations could make a difference in the negotiations, and both the buyer and the seller just might improve their tax position.
While we all think about airplanes when we think about aviation depreciation, there are a lot of other things involved in aviation besides the aircraft. Do you own a hangar? Regardless of whether you own or rent your hangar, do you have any tools in there such as air compressors, hoists, workbenches, dedicated wiring or partitioned-off office areas? All of these items are depreciable and they may not have the same depreciable life as your plane. The new regulations amplify the point of selecting the proper depreciable life and method the very first year. If you make a mistake and call a seven-year asset a five-year asset, the IRS will tell you to slow down the depreciation deduction and use seven years. But if you take a five-year asset and mistakenly classify it as a seven-year asset, then the IRS can say that you don't get the last two years' depreciation. To correct this, filing an amended return or Form 3115 to request a change in your accounting method may not work. You may have to file a request with the IRS in the form of a private letter ruling to make everything right. Sometimes, there's truly a question mark on what is the proper life. My advice is to select the shorter life rather than the longer life. You can always slow down, but it's hard to speed up the depreciation deductions.
about aviation depreciation, there are a lot of other
things involved in aviation besides the aircraft. Do
you own a hangar?
There's a blessing to aircraft owners in the new regulations. My old advice was that when an annual inspection or TBO was coming up, I'd recommend that you bring the plane in early just to get the ordinary and routine items cleaned up as normal repairs and maintenance. Then when the plane was in for its annual or TBO, there should be little to no doubt as to what the annual consisted of, and then you'd have to make a decision about expensing or capitalizing the cost of the annual or TBO depending on what became involved. But you'd take care of the routine things ahead of the annual and they wouldn't be a factor in the annual. The maintenance expense would have been protected, and maybe there wasn't enough other stuff done at the annual that would require the cost of the annual to be capitalized. Now I have the luxury of changing my advice. The regulations make it clear that as long as normal repair work can be identified and segregated at the time major capitalized work is being done that the repair items, assuming they're identified and separately stated, will be treated as repair and maintenance. Make sure your A&E mechanic helps you out with this.
The repair regulations are found under 1.263(a)-1T. Be careful not to confuse them with 1.263A. They aren't the same.
Tax deductions for flight lessons will depend on circumstances and whether or not the expense is customary relating to the particular business environment.
Final Regulations For Aircraft Entertainment Use
The issuance of the final regulations for Code Section 274 still classifies your airplane as an entertainment facility and as such is subject to the rules of IRC Section 274. Since the Sutherland case back around the year 2000, the IRS has been trying their best to either disallow tax deductibility of certain nonbusiness or personal use of business aircraft, or have it be a source of taxable income to the individual who took the personal flight. The IRS tried to prevail in court—but lost. Then the IRS went back to Congress and had Congress rewrite Section 274. Now the IRS has handed down how they're going to interpret and apply Code Section 274. The taxpayers have been given a small window of time to comply with the final regulations, which take effect for tax years beginning after July 31, 2012. For calendar year taxpayers, this means that starting January 1, 2013, you will have to play by the new rules.
To be clear, the IRS is going after businesses who claim a tax deduction for their aircraft being used for personal nonbusiness purposes by "specified individuals." These "specified individuals" are defined as those who own directly or indirectly more than 10% of a business, who's a director or officer of a business, or someone who doesn't have an officer or director title but has comparable responsibilities and duties to that of a company officer or director. Basically, no more name games or title games. The final regulations also deal with two other user classes of aircraft users. These are employees who aren't "specified individuals" and a final class of individuals who aren't employees and aren't specified individuals. That covers every possible person. Nobody is given a free pass from the regulations. They'll just be handled differently.
The final regulations basically followed the 2007 proposed regulations. Even though the answers weren't the ones we wanted, the final regulations did resolve many of the questions and points that were being tossed around regarding what expenses were to be included as operating expenses and the alternatives to charging those expenses to a passenger. Basically, all of the aircraft expenses (fixed and variable) are being thrown in and counted. It's imperative that the regulations be followed. Otherwise, you run the risk of not being able to deduct your aviation expenses, which includes depreciation. If you discover either on your own or upon an IRS audit that you have run afoul of the rules, then the individual who took a personal flight may have taxable income to report and there could be another obligation for unreported and undeposited payroll taxes by both the employee and the employer. And naturally, there are penalties pertaining to the payroll tax issue. It never ends and it never quits.
If you own a plane, my advice is that either you or your tax preparer have Code Section 274 committed to memory and that you maintain a seating chart for every seat in the aircraft and you know who's in every seat on every flight. Then, deal with the tax issues to everyone accordingly. It costs a lot of money to buy an airplane without considering the operating cost, and depreciation deductions alone are tremendous. You won't be happy if these deductions are disallowed by the IRS.
Are Flying Lessons Deductible?
This question pops up more frequently than you can imagine. "Can I get a tax deduction if I learn to fly a plane?" I get this question from people who are just starting to get interested in aviation, as well as those who have been flying for many years and want to upgrade their ratings. Oftentimes, the person new to aviation depending on their facts, circumstances and situation has a better chance of getting to "yes" than someone already holding their ticket.
This issue went to trial early in 2012. Even though the taxpayer lost, had the taxpayer fulfilled his responsibilities, the judge just may have gone along with the taxpayer and let the taxpayer have the deduction. But the taxpayer failed in his responsibilities so the judge had no choice but to rule not necessarily for the IRS but against the taxpayer. All the IRS had to do was to sit back and watch because the taxpayer brought nothing to trial.
To be tax deductible, an expense must be ordinary, which is considered to be normal, usual or customary relating to the particular business environment for which the expense was incurred as well as be necessary to the particular business environment, which is defined as being appropriate and helpful to the taxpayer's trade or business. This is a classic definition from Code Section 162.
In the case under discussion, the taxpayer was involved with real estate as a commercial realtor as one of his business interests. For three years, he hired a pilot to assist him in taking aerial photos of property he was trying to list and sell. Then he got the idea to get his pilot's license and his own plane and save the expense of hiring a pilot. This is somewhat reasonable on the surface. But he ran into the following problems with the judge. He couldn't convince the judge that becoming a pilot maintained or improved his skills as a commercial realtor. So there went the education angle. He had no valid argument why he was in a better business position than he was before when he hired a pilot for the three preceding years. So there went the ordinary and necessary argument. The taxpayer failed to produce receipts and/or invoices for the flying lessons and other expenses, and he stated to the judge that he didn't know that he needed to keep those records. So there went the burden of proof issue. And there went the case.
Every case and situation stands on its own. The courts will consider and allow deductions for flying lessons where the deduction is legitimate. But there has to be a bona fide business purpose and you must meet the burden of proof standard. Oftentimes, these deductions are generated by a closely held business that's owned by one person or a small number of individuals. The owner(s) agree that there's a bona fide need for a plane, and the economics of getting someone ticketed and owning a plane are more beneficial than the cost of leasing or chartering an aircraft or commercial airline travel. As such, one lucky soul gets the pleasure of learning how to fly. When I have this situation, I recommend that his job description and duties be revised to include that this person will acquire their pilot's license, maintain their currency and maintain their medical at all times. This is so the plane can be flown at a moment's notice. I also recommend that a statement be put in the corporate annual minutes describing the benefits of airplane ownership and reaffirming the business decision to continue with the ownership and expenses of the plane.
There are approximately 15,000 airports in the United States. Of these airports, approximately 5,000 have paved runways. Of these, 376 airports have regularly scheduled flights. Also, 86 airports process more than 1 million passengers a year. Only 25 airports process more than 10 million passengers a year. If long- distance travel by your company is an issue, I suspect that there are many small airports that can handle the smaller planes of general aviation that can get you to your destination a lot easier than going through a major terminal. The cost of getting an executive out in the field, getting their job done and returning them back to the office will probably be less than going the commercial route when you consider all of the time costs associated with the trip. Time is money.
Pilots want to increase their skills and expertise. As such, they want to advance their ratings. And this will be a problem when it comes to being tax deductible. Sooner or later, you'll become so rated that you'll have qualified yourself for a new profession. You technically can get a job as a commercial pilot. It doesn't matter that you have no intention of doing so; the defining point is that you have qualified yourself for a new profession. And that fact will disallow the deduction.
General aviation will be greatly impacted by these and other changes for 2012. The time and effort to keep up with the tax arena will be a big benefit as you deal with your tax preparation.
O. H. "Harry" Daniels, Jr. is a CPA, a CFP licensee and a certified valuation analyst. He's a partner with the firm of Duggan, Joiner & Company, Certified Public Accountants and can be reached at email@example.com. Daniels has held his license as a private pilot since 1991.