Does the 2017 tax law benefit business aviation?
Last December, Congress passed the biggest—and probably the most controversial—tax bill since 1986. How does this “tax reform” affect business aviation?
The most obvious benefit is that it ends the long battle with the Internal Revenue Service over taxing payments by aircraft owners and lessees to aircraft management companies. If you give someone a ride on your business jet and charge for it, you’re required to collect the 7.5 percent federal transportation excise tax. But suppose you hire a management company to help operate your jet. The steady rise of companies in the business of managing private aircraft gave the IRS an incentive to argue that those companies, not the aircraft owners, had what the tax agency calls “possession, command, and control” of the airplanes; as such, said the IRS, the owners’ payments to the management companies should be subject to the 7.5 percent tax. In other words, you should be paying a tax to fly on your own aircraft.
The years of confusion and audit battles that ensued benefited lawyers and accountants more than the U.S. Treasury. Throughout, the National Business Aviation Association and other industry groups steadfastly maintained that management-company clients (the aircraft owners and lessees) in fact retained possession, command, and control of their aircraft for flights under FAR Part 91 and that they simply hired the management companies to help them, not to provide them with transportation. (FAR Part 91 is the Federal Aviation Regulations category that covers non-commercial flights.)
Congress saw the light by providing in the new tax act that payments by aircraft owners and lessees for management services are not subject to the transportation excise tax. Though in some quarters this is viewed as a gift to rich jet owners, it’s the right result and a major victory for business aviation. Gifts to the rich lurk elsewhere in the act.
The legislation sends a more complex message regarding tax depreciation and recapture. Under prior law, to the extent that you used an aircraft in business, you could “write it off” (depreciate it) for tax purposes on a five- to 12-year schedule, depending on the nature of the business use. Then, when you sold the aircraft, the depreciation would be “recaptured” and taxed. For example, if you purchased an aircraft for $20 million, depreciated it to $0 for tax purposes and then sold it for $12 million, you’d be subject to tax on $12 million.
You could entirely avoid this tax, however, by purchasing a replacement aircraft in a tax-free or “like-kind” exchange. If the replacement aircraft cost $25 million, its tax basis would be reduced by $12 million and the $13 million balance would be available to be written off for tax purposes going forward.
The new act, however, repeals like-kind exchanges of aircraft and other tangible personal property, while preserving like-kind exchanges of real estate. By itself, this change provides you with an incentive not to sell a depreciated aircraft (and thus not to buy a replacement) because you’d be unable to avoid taxable gain on recapture. The act compensates for this, however, by resurrecting 100 percent expensing for tangible personal property. The NBAA and other industry groups worked hard to make sure the act allowed for 100 percent expensing not just for new property but for preowned property as well. Business aviation achieved a significant last-minute victory when the Senate joined the House in agreeing to this provision.
Putting aside the question of why, as a matter of tax policy, what’s good for an airplane isn’t also good for a building, at first glance this sounds like a welcome change. No more complicated depreciation schedules; just write off the new or preowned aircraft completely when you buy it, and then pay tax on the sale proceeds when you sell it. The repeal of like-kind exchange means sellers are relieved of the pressure to close within the tax-code deadlines (though they may want the 100 percent write-off on the replacement aircraft to occur in the same tax year as the recapture).
There are problems, though.
First, 100 percent expensing is not as simple as it sounds; it assumes, for example, that you predominantly employ the aircraft in “qualified business use” and the entertainment disallowance does not apply to flights.
Even if you meet these standards during the year you take delivery of the aircraft, you may fail to meet them in later years, so complicated tax rules may still apply and your 100 percent day-one deduction may turn into a multi-year straight-line write-off.
Second, though the demise of aircraft like-kind exchanges makes the extension of 100 percent expensing to used aircraft extremely important, it’s not a perfect solution. The idea behind bonus depreciation was to stimulate the sale, and thus the manufacture, of factory-new assets like business jets.
Thus, making 100 percent expensing also available on preowned aircraft undercuts the whole purpose of allowing an immediate write-off in the first place and may on balance actually hurt aircraft manufacturers. Finally, the act’s repeal of like-kind exchange is permanent, but 100 percent expensing is to be phased out beginning in 2023, presumably to help raise cash to start paying down the deficits created by the big tax cuts in the act.
The act makes changes regarding the deduction for tax purposes of expenses, including aircraft-travel-related expenses. Except for reasons of employee safety, companies can no longer deduct the cost of flying employees from their residence to their place of employment, though some details of this change remain unclear. The act also disallows deductions for entertainment travel even when directly related to a business purpose. Further, employees will no longer be able to deduct employee business expenses, including for aircraft travel, to the extent that they exceed (when combined with other miscellaneous itemized deductions) 2 percent of adjusted gross income. None of these changes can be said to benefit business aviation.
Oddly, a proposed change that didn’t make it into the final bill would have disallowed a deduction by lower-level employees for expenses related to “entertainment” travel in excess of the amount included in income or reimbursed. Congress amended the tax code in 2005 to disallow that deduction for “specified individuals” of a company (generally owners, directors, top executives, and their personal guests). Why a company should be able to deduct such expenses for lower-level but not upper-level employees always struck me as mysterious. Arguably, retention of the deduction for lower-level employees is a win for business aviation, but not one that makes the tax code simpler or more rational.
Is business aviation better off under the new act? Maybe. But we would be better served by a more thoughtful process designed to develop reasonable changes instead of the ill-conceived “reform” served up by Congress in its politically charged 2017 year-end fire drill.