“If you write off a business aircraft, that’s a huge red flag and you will be audited.”
This is a very common sentiment I hear when speaking to prospective aircraft owners as well as tax advisers across the country. IRS audit risk is a very important planning consideration as we design an ownership structure for our clients. The art of aviation tax planning is to devise an ownership structure that satisfies the myriad of competing enforcement agencies: IRS compliance and audit risk, Federal Aviation Administration regulations compliance, state sales and use tax strategy, financing and banking requirements, etc.
With proper planning, getting audited by the IRS is still an extremely rare occurrence. Certain reporting scenarios are indeed high risk, which will draw attention from IRS auditors. Staying away from these high-risk reporting scenarios will be the key to stay under the IRS audit radar. For example, if you report your business aircraft on a Schedule C sole proprietorship tax form—without other business activities—your audit risk augments significantly.
Defending an IRS Audit
Even though it is a rare occurrence, we advise our clients as if they will be audited. Keeping extremely detailed records to support the business use of their aircraft is of utmost importance. If you are audited, the key to success is to establish that the aircraft is ordinary and necessary to support your business activities and support this claim with contemporaneous documentation. The burden of proof rests with the taxpayer.
Handling of Personal Use
The regulations on how personal use is handled have changed over the years. Personal use of a business aircraft is the focus for the IRS due to the perceived abuse by corporate executives. Reimbursing your company for personal use is problematic in many aspects. Having dry leases with principals for their personal use is cumbersome. Understanding the current fringe benefit rules and applying the correct classification of flights can streamline the compliance process and avoid costly mistakes.
State Sales Tax Audit Risk
Unlike IRS income tax audits, state sales and use tax audits occur on a regular basis. In some states, it is a certainty that an aircraft owner will receive a sales or use tax inquiry from the state Department of Revenue after the purchase of an aircraft. Therefore, if you are claiming a sales tax exemption on the purchase of an aircraft, you should be prepared to present documentation and flight logs to support the exemption claimed.
With the advancement of flight tracking websites and the requirement of state aircraft registration, it is unlikely that you can avoid scrutiny of your aircraft from state taxing authorities by using a Delaware or Montana LLC. This state tax avoidance strategy is playing a game of hide and seek. If caught, you will owe the sales/use tax on the purchase plus penalty and interest.
State sales and use tax planning varies greatly from state to state. Some of the more common exemptions that may be available are:
- Interstate commerce exemption.
- Occasional or private party purchase exemption.
- Rental and leasing exemption.
- Commercial use exemption.
- Due to the mobile nature of an aircraft, it is important to determine if your aircraft may be subject to the jurisdiction of multiple states and locales, such as the state of a second home or office location.
As the year-end nears, and considering heightened IRS audit interest in private aircraft, this may be the perfect time to conduct a thorough review and inspection of your aircraft recordkeeping practice, review flight logs and gather documentation to support business flights.
Daniel Cheung is a principal of Aviation Tax Consultants, LLC (aviationtaxconsultants.com). ATC’s consulting services include the elimination or reduction of sales and use tax at the time of purchase, maximizing income tax savings, controlling the cost of personal use of the aircraft, complying with passive activity loss and related party leasing rules and Federal Aviation Regulations. Cooperation with the client’s current tax and legal advisers is welcome and encouraged.