“[New billionaires in fast-growing countries] have to buy longer-range airplanes. If you’re flying from Mongolia to Nigeria, it’s either a three-day journey flying commercial or a nine-hour flight on your jet.”
Borrowing the Company Jet
Calculating the cost of personal use is as complicated as it is important.
When an employee takes a personal flight on his company’s aircraft, how do you calculate the trip’s cost or value? The answer depends on who’s asking the question and why.
The Federal Aviation Administration generally prohibits passengers from paying for flights that aren’t operated under a commercial certificate. “Payment” means forking over any kind of direct or indirect compensation. The FAA says, however, that if the flight is “within the scope of and incidental to” a company’s business, it can charge the employee the cost of “owning, operating and maintaining the airplane.”
That’s a broad standard for figuring costs. In interpretations, the FAA has said it’s acceptable to use the cost of aircraft usage as established by the company’s accounting department in the normal course of business and that the cost could represent a pro-rata portion of “all fixed and variable overhead expenses associated with the aircraft.” More recently, as part of a convoluted analysis that sowed more confusion than elucidation, the agency said that the cost could even include depreciation of the airplane.
On the other hand, if an employee’s flight is for personal purposes (and is thus not “within the scope of and incidental to” company business), such charges are prohibited. Instead, FAA regulations permit the employee in some cases to “time share” an aircraft for an amount equal to twice the actual fuel costs, plus certain stated expenses. Barring astronomical fuel prices, this amount won’t cover all of the company’s expenses for the flight—certainly not a pro-rata portion of the cost of owning, operating and maintaining the aircraft.
Compare this with the Internal Revenue Service’s approach. The IRS is interested in the cost or value of a flight for two main reasons. First, if an employee travels on company aircraft for personal purposes, the agency treats the flight as a perquisite and the employee as a recipient of taxable income. The IRS gives the company a choice in calculating the amount of that income. To the extent that the employee doesn’t pay for the flight, the company must impute his income using either the ride’s fair market value or a calculation method called SIFL. The former is basically the cost to charter the aircraft, while the latter reflects the cost of first-class airfare. Needless to say, the two numbers will be very different.
The second reason the IRS is interested in the cost or value of a flight is to determine the company’s deductible expenses for tax purposes. Companies usually want to deduct the cost of employees’ personal flights on their aircraft as a business expense. In 2004, though, Congress made this more difficult by limiting the write-off for certain top executives (so-called “specified individuals”) to the amount paid by (and/or income imputed to) those executives when the flight is for their “entertainment, recreation or amusement.” As a result, whenever a specified individual takes a non-business flight, a big chunk of the company’s expenses are often at risk of being disallowed for tax purposes.
How big a chunk? Since the IRS lets the company calculate income to the employee for the flight based on charter rates or Standard Industry Fare Level, one might think the business could use the same approach to calculate its lost deductions. Unfortunately for the company, that doesn’t work. IRS regulations provide that all fixed and variable flight costs—including an allocable portion of any interest expense used to finance the purchase of the aircraft, plus lease payments and tax depreciation on it—are at risk of being disallowed.
IRS rules for how to calculate these costs and assess the amount of the tax deduction disallowed are extraordinarily complicated and sometimes counterintuitive, and enterprising aviation tax accountants have created software to help the company do the job. The bottom line: if top executives frequently use the aircraft for personal “entertainment, recreation or amusement,” the company’s tax bill will go up.
Ironically, this inability to deduct entertainment flight costs creates yet another “cost” for the company—taxes—and yet another headache (this time for public companies) in calculating the cost of personal-use flights.
Like the IRS, the Securities and Exchange Commission regards free or discounted flights for employees on the company aircraft as a perquisite. In the case of free flights on corporate aircraft for certain top executives (often called “named executive officers”) that aren’t part of their employment duties, the SEC requires public companies to report what the commission calls the “aggregate incremental cost” of the flights as “other compensation” to such executives in the proxy statement. Unlike the FAA, the SEC isn’t focused on whether the executive can pay for the flight, and unlike the IRS, it doesn’t care what the actual value provided to the executive is. Its only concern is the additional cost the company incurs in providing the transportation, which has traditionally been thought to be similar to the direct operating costs (DOCs) of the flight—an amount less than, say, the cost of chartering the aircraft.
But as we just noted, if the IRS deems the executive’s flight “entertainment,” the company stands to lose significant tax deductions. Is this also an “aggregate incremental cost” that should be disclosed in proxy statements? Though loss of a tax deduction isn’t a “cost” per se, in an abundance of caution, some companies have been disclosing the fact (if not the amount) of the lost deductions as a result of personal-use flights. And, just to come full circle, if the deduction is a cost, receiving a tax deduction might be compensation, which is exactly what an old FAA interpretation concluded in proscribing flights by a tax-savvy operator who claimed they were conducted at “no charge.”
Even in this simplified account of a complicated subject, it’s apparent that companies face contradictory government standards in dealing with non-business flight expenses for employees and others that are certain to keep aviation lawyers and accountants busy for years to come.
Jeff Wieand is a senior vice president at Boston JetSearch and a member of the National Business Aviation Association’s Tax Committee.
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