|EXECUTIVE SUMMARY |
| SINCE SEPTEMBER 11, BUSINESSES HAVE INCREASED their use of company-owned aircraft for employee travel. To successfully defend the cost of this travel as a business expense, it must be ordinary, necessary, reasonable and not lavish.
UNDER IRC SECTION 162(a), COMPANIES CAN DEDUCT travel expenses while employees are away from home pursuing a trade or business. An expense is ordinary if it is common and accepted. In Noyce , the court said the taxpayer incurred ordinary expenses when the cost of replicating the travel schedule via commercial charter would have been more than the cost of operating a private business aircraft.
THE COURTS REQUIRE TAXPAYERS TO PROVE AIRCRAFT they claim as business deductions are necessary for their business and not just for the owner’s benefit. In Richardson the taxpayer proved this by maintaining logs to prove his personal use of the plane was limited. He also reimbursed the company for any personal use.
RICHARDSON ALSO ESTABLISHED A REVENUE-GENERATOR test of reasonableness. The Tax Court found the taxpayer’s expenses were reasonable because they generated substantial income in the years at issue. In Kurzet the 10th Circuit overruled the Tax Court in finding expenses of Lear jet travel were reasonable based on the cost and time savings.
CPAs SHOULD ENCOURAGE COMPANIES THAT OWN business aircraft to maintain a log to prove the percentage of business vs. personal use. Documentation is a key factor to ensure the company gets the maximum tax advantage for using this equipment.
|KAREN C. MILLER, CPA, is a sole practitioner in Lexington, Tennessee. She also is an accounting instructor at Union University in Jackson, Tennessee, and a PhD candidate at the University of Mississippi. Her e-mail address is KcmillerCPA@aol.com . TONYA K. FLESHER, CPA, PhD, is professor of accounting at the University of Mississippi at University. She is director of the school’s Tax History Research Center and a member of the AICPA minority initiatives committee. Her e-mail address is email@example.com . |
he concept of business travel changed forever on September 11, 2001. The inconveniences and risks businesspeople now experience with commercial air travel have resulted in the increasing popularity of company-owned aircraft. With this shift CPAs must be prepared to justify expenses for the use of such aircraft as a business deduction for their employers or clients. A successful defense of this travel deduction requires evidence the expense is ordinary, necessary, reasonable and not lavish. Adequate planning and appropriate documentation can help companies maximize their use of corporate aircraft and support tax deductions.
What makes a business expenditure ordinary? Even before September 11 the use of company-owned aircraft for employee travel had become common as businesses needed to be mobile to be successful. The need for mobility, along with higher prices for commercial air travel, created a climate where owning and operating an aircraft no longer was considered lavish. In a survey by the National Business Aviation Association (NBAA) of companies that use turbine-powered aircraft for business travel, passengers reported taking an average of 21 trips by air in a six-month period, using company planes for 60% of them.
|In the NBAA’s 1999 utilization strategies survey, 45% of organizations reported they had increased their use of company aircraft in the past 12 months. Approximately one-third expected access to business aircraft to increase over the next three years. The NBAA also reported a surge in shared ownership of planes among smaller companies that wanted the convenience of private jet travel.
|Business on the Move |
Executives have been using company aircraft twice as often since September 11, 2001.
Source: International Business Aviation Council (IBAC), www.ibac.org .
Companies can deduct travel expenses while employees are working away from home in the pursuit of a trade or business as ordinary and necessary expenses under IRC section 162(a). Treasury regulations section 1.162-2 explicitly includes “travel fares” that are reasonable, necessary and directly attributable to business as valid trade or business expenses. The law considers an expense ordinary if it is “common and accepted,” comparing the taxpayer with “the group, the community, of which he is a part” ( Welch v. Helvering , 290 US 111, 114, 54 Sup. Ct. 8, 78, 1933). In Noyce v. Commissioner (97 TC no. 46, 97 TC 670 (1991)), the court said the taxpayer incurred ordinary expenses when there was a clear business advantage and when the cost of replicating the travel schedule and the time savings via commercial charter would have exceeded the costs of operating a company aircraft.
Because personal aircraft had for so long been viewed as a lavish business perk, the courts require taxpayers to prove that aircraft they claim as business deductions are actually necessary for their business and not just for the owner’s benefit. To ensure full deductibility, CPAs need to help taxpayers document the business use of their airplanes. In Richardson v. Commissioner (72 TC Memo, 348 (1996)), the taxpayer maintained logs to prove he used his plane personally for only 3% and 9% of the time for the two years in question. He reimbursed the company for any personal use. With no current limits on business aircraft expenses as a luxury item or limited-use asset, the law allows a full deduction for expenses the taxpayer can support by providing proof of the business necessity to obtain a full deduction.
Some taxpayers have used the notion of urgency to support the necessity of business aircraft. The Tax Court in Richardson addressed the use of the airplane for quick responses to emergency situations. Revenue ruling 70-558 allowed a deduction for the business use of aircraft when the employer did not require the use but permitted employees to travel by the company plane in urgent situations. The IRS allowed the deduction to the extent the amount exceeded the standard travel reimbursement rates for government officials.
Business aircraft allow employees to travel when they can’t get commercial flights. This travel efficiency allows more time for meetings and fewer delays. In Noyce , the Tax Court held that a corporate official used the business aircraft in the necessary execution of his duties for travel not regularly or easily scheduled. In Richardson , the taxpayer argued he used the plane to enable him to travel to more than one location in a single day and to avoid room-and-board costs, something he couldn’t accomplish with commercial travel. The Tax Court agreed and found the expenses to be necessary. Heineman v. Commissioner (82 TC 538 (1984)) said an expense is necessary if it helps a company carry on its trade or business. In both Noyce and Richardson the Tax Court upheld the character of necessity Heineman established. “Necessity” requires an expense to be both helpful and appropriate to the business.
Regulations section 1.162-2 adds a reasonableness criterion to the ordinary and necessary business expense: An expense should be reasonable in amount in relation to its purpose. CPAs may find the reasonableness test to be the most subjective one taxpayers will have to defend when using business aircraft. However, judicial decisions for reasonableness have not been as consistent as those for ordinary and necessary.
Richardson may have established a revenue-generator test of reasonableness. Richardson used his business aircraft for management services and had related expenses that were 26% and 17%, respectively, of the management services revenue for the two years in question. The taxpayer had also billed some of his clients for the business aircraft travel as part of his management fees. The Tax Court found these expenses to be reasonable because they generated substantial income during the years at issue.
|On the other hand, Noyce may have established an expense test for reasonableness. In that case the Tax Court replicated the taxpayer’s travel schedule and time savings via a commercial charter carrier and determined it would have exceeded the cost of operating the private airplane. The court allowed Noyce all out-of-pocket expenses of operating his airplane with respect to business-related flights to the extent they exceeded reimbursable expenses including the business percentage of depreciation.
One of the most recent and controversial cases on the reasonableness of business aircraft deductions CPAs should be aware of is Kurzet v. Commissioner (222 F3d 830, 10th Circuit (2000)). The Tax Court denied all of the Kurzet’s expenses for Lear jet travel, claiming they were extraordinary and extravagant to avoid a slight inconvenience and allowed the taxpayer to deduct only the cost of first-class travel on a commercial carrier for trips to a timber farm in Oregon.
|Business Aircraft Resources International Business Aviation Council (IBAC)
999 Rue University
H3C 5J9, Canada
Web site: www.ibac.org
National Business Aviation Association Inc. (NBAA)
1200 Eighteenth Street NW
Washington, D.C. 20036-2506
Web site: www.nbaa.org
The 10th Circuit Court of Appeals disagreed with the method the Tax Court had used to calculate reasonableness saying the lower court used drastically overinflated numbers. The Tax Court underestimated the number of business trips taken, did not give sufficient weight to time savings and should not have used depreciation to consider reasonableness. The result was it based its assessment on inflated figures. The 10th Circuit recalculated reasonableness using the number of trips flown times 12 hours saved each trip times Kurzet’s time at $200 an hour and added this to the Tax Court’s finding that first-class round-trip airfare was $1,600. When it compared these expenses with the cost of operating the Lear jet, the 10th Circuit found the expenses to be reasonable.
Field service announcement (FSA) 200137002 cites both Noyce and Kurzet for the deduction of reasonable expenses. The ruling cites Noyce for the full deductibility of Lear jet expenses if they are ordinary, necessary and reasonable. However, the ruling cites Kurzet for expenses that are ordinary and necessary but not reasonable. If an otherwise ordinary and necessary expense is unreasonable, the ruling suggests a deduction limited to the cost of first-class airfare.
REASONABLE BUSINESS PURPOSES
A company’s first step in successfully defending a business aircraft deduction is to use the airplane in an enterprise that operates at a profit. CPAs will find that businesses the taxpayer does not engage in for profit won’t be allowed any business deduction. The IRS will scrutinize large business aircraft deductions from entities that generate little or no profit. Personal airplane expenses disguised as trade or business expenses aren’t justifiable deductions. Ordinary expenses should be common and accepted, with a business advantage.
In the 1999 NBAA survey, corporate executives gave these reasons for using business aircraft:
Employee safety and industrial security.
Getting their key employees to the right place at the right time.
Getting employees onto the customer’s turf.
Transporting management teams to organization sites.
|The IRS provides no specific guidelines on reasonableness, making the test very subjective. As a result CPAs should advise companies using business aircraft to be prepared to document reasons such as those listed above—and any other business purposes—to help defend aircraft use as an ordinary expense.
Necessary expenses should produce time and cost savings relevant to the business. According to chief pilots in an earlier 1997 NBAA survey, company aircraft mainly were needed because employees could not meet business schedules efficiently using commercial airlines. The second major reason was to reach locations commercial airlines did not serve. CPAs can use these examples to document the time and costs savings business aircraft generate.
If the taxpayer cannot support reasonableness, the IRS and the courts will limit the deduction for aircraft use. Richardson and Kurzet give two examples for the reasonableness test. As in Richardson , CPAs should consider using a revenue-generator test. Compare business aircraft deductions with the revenue generated in the divisions or areas of the business using the equipment for reasonableness. Following Kurzet , consider using an expense test. Accountants can compare the cost and time savings of the business aircraft with the expenses the taxpayer would incur for charter or first-class commercial flights.
|PRACTICAL TIPS TO REMEMBER |
When advising companies seeking to deduct the expenses of company-owned aircraft, CPAs should keep this advice in mind.
Make sure the company can document the expenses as ordinary and necessary under IRC section 162(a).
Advise the company to keep a log that tracks business use of the airplane. It should include the number of trips flown, the purpose of each trip, the number of people on board, their positions in the company and the locations visited.
Companies using business aircraft should be prepared to prove the expense was reasonable when compared with the cost and scheduling of commercial air travel.
Recommend that companies track all personal use of business aircraft and bill employees appropriately for such use.
MAINTAINING APPROPRIATE DOCUMENTATION
A successful defense will require the company to have adequate documentation. CPAs should advise companies to maintain a log of business aircraft use proving the percentage of business vs. personal use. An efficient log should include the number of trips flown, the purpose of the trip, the number of people on board and the locations visited. CPAs can use a cost-benefit analysis to document the position held and the hourly cost and value of the passengers.
According to the 1997 study, 28% of the passengers on business aircraft were top management and 49% were middle management. Companies estimated the cost and the related value of each of these passengers to their employers at $259 and $551 per hour, respectively. CPAs can use surveys such as this one to document what is ordinary. Companies also should provide evidence of partial billing of business aircraft expenses for personal use. Reimbursement statements can also benefit employees paying for nonreimbursed travel expenses out of pocket. Finally, the company should document all of the operating expenses of the business aircraft including fuel, maintenance, hangar costs, staff, training and licenses. Documentation is key to ensuring a tax advantage for using corporate aircraft as a trade or business expense.
TAX VS. BUSINESS BENEFIT
Companies should make the decision to use business aircraft based on the efficiency and value to the enterprise. The growing demand for mobility and the rising cost of commercial airfares have made using business aircraft a smart move for many companies—not just a tax deduction. Business travelers scheduling commercial travel unexpectedly may pay anywhere from four to eight times more per ticket than leisure travelers, who can tolerate delays. The savings to a company from using business aircraft for frequent and unanticipated travel by one or more valuable middle to top-level management personnel can often exceed the commercial airfare. The savings a company can realize by avoiding overnight lodging and meals are considerable as well. Using business aircraft also means employees can spend more time at home, which is a large quality-of-life advantage in retaining middle and upper management. If used efficiently, business aircraft can be a large asset to profitable businesses.
THE EVOLUTION OF BUSINESS TRAVEL
Business growth and mobility play a significant role in the increasing use of corporate aircraft. What were once lavish perks have become ordinary, necessary and reasonable expenses when used for business purposes. Business travel has evolved even further since September 11 as workers seek to avoid the long lines and security checks of commercial air travel. When the IRS scrutinizes company aircraft use, subsequent judicial decisions will be based on a taxpayer’s ability to provide supporting documentation of the reasonable business expense vs. owner benefit. Therefore, CPAs should encourage employers and clients to plan adequately and to maintain the appropriate documentation to support their aircraft expense as ordinary, necessary and reasonable.