
Surviving a tax audit
As a big-ticket asset promising large potential tax adjustments, a business jet easily captures the attention of IRS auditors. Given the woefully complicated tax rules applicable to these aircraft, who can blame the IRS for seeking additional revenue opportunities in the flight department?
The best way to survive an audit is never to have one. Even if you buy a fractional share or lease an aircraft–options that are arguably less likely to result in an audit than purchasing a jet outright–it’s important to be mindful of the tax traps that business airplanes often unwittingly fly into. Just reciting the names of some key danger zones can be chastening: at-risk rules, passive losses, hobby losses, entertainment disallowance–plenty of audit potential lurks in these areas. The good news is that even if you cut corners and made mistakes in tax planning when you acquired your aircraft, it may not be too late to reverse or at least minimize the damage.
Basically, there’s only one way to run into trouble with the IRS: failing to pay the taxes you owe on a timely basis. This can happen because you underpaid or ignored specific taxes, such as the transportation excise tax or a taxable fringe benefit; or because you improperly took deductions against taxable income for aircraft-related expenses.
The former frequently comes down to the facts of the case: was there taxable transportation or a taxable fringe benefit? Talking to the IRS about such issues can be frustrating since there is often a major disconnect between aviation tax professionals and the government agency about the facts regarding situations subject to tax. (Witness, for example, the notorious Air Transportation Excise Tax–Audit Technique Guide, which the IRS published in 2008.) Minimizing audit risk in this arena may simply involve doing your best to comply with the rules while pulling down the blinds and hoping for an intelligent, not overly zealous revenue agent.
The second area–improper aircraft-related taxdeductions–involves complicated law. The threshold question can be particularly problematic with regard to business aircraft: do costs related to its use represent an ordinary and necessary business expense? Business aviation CPA Jed Wolcott in Fort Lauderdale, Fla., sees increasing audit activity in this area, especially for aircraft owned by special-purpose entities or where aircraft expenses are disproportionately large by comparison with revenues and other expenses.
“The company should justify that it has legitimate business reasons for using private air transportation, such as improving the efficiency of key executives,” Wolcott said. Operating a roadside lemonade stand in Palm Springs, for example, would not reasonably require use of a Citation X to transport the owner to Chicago to stock up on lemonade mix. Ideally, Wolcott noted, the company will document in writing that it has studied the issue and reasonably concluded that private air transportation was beneficial.
A recordkeeping checklist for aircraft owners
Here are the records you should keep contemporaneously for each person on each flight leg:
• Date of flight
• Departure airport
• Arrival airport
• Flight hours and miles
• Passenger manifest
• Purpose of flight for each passenger
• Relation