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The Preacquisition Phase
Taking flight: Tax Aspects of Aircraft Ownership

by Victor C. Anvick, MST, EA, Atis Group LLC, copyright March 2007

The first step in the preacquision phase is to document why Greenacre needs its own plane following the ordinary, necessary and reasonableness issues of IRC section 162 and the regulations, cases and other citable authority. Experience has shown that clients who cannot cite a bona fide reason for aircraft acquisition before the purchase have greater difficulty justifying it to an IRS agent three years after the purchase.

Greenacre has identified several cancelled or interrupted business trips as well as examples of strained relations with customers and the inability to have senior management at a branch office quickly in the event of a crisis. These incidents go well beyond the ordinary and necessary standard in section 162. Acquiring an aircraft seems to be mandatory if the group is to continue its profitable existence and future expansion. The cost of owning and operating an airplane is necessary in the sense that it is "appropriate and helpful" to the development of Greenacre's business. It is ordinary in the sense that it is a "normal and natural response" to the conditions under which Greenacre does business. (See Commissioner v Tellier, 383 US 687,689 (1966).)

The next step is to develop a travel profile. Factors such as the number of passengers, average trip length, amount of baggage, destinations and number of trips per month will dictate the class of aircraft the company buys. Only then does it make sense to start collecting cost data. For example, if Greenacre's management needs to go to Hawaii for a once-a-year industry convention and insists on taking the company aircraft rather than a charter or commercial flight, many fine aircraft will be eliminated from consideration because of lack of range. On the other hand, if Greenacre can charter a plane for the Hawaii trip and purchase an aircraft that will satisfy most of its continental U.S. needs, it could realize substantial acquisition savings as well as save on fuel, maintenance, insurance, property taxes, sales taxes and other costs.

Greenacre decides to hire an aircraft acquisition consultant to evaluate its current and anticipated travel needs and work with its CPA to develop acquisition costs, operating and nonoperating expenses, budgets and tax projections.

During the preacquisition phase companies also should decide whether an existing business will purchase the aircraft or whether they should form a separate entity Because of liability issues, it has become increasingly popular for aircraft owners to set up a limited liability company or S corporation to own and operate the plane.

Unfortunately, many such single-purpose entities or "flight department companies" operate outside FAA regulations. They have no business plan or ascertainable business activity other than carrying company officials, employees and guests. The preamble to Amendment 91-101, cited in FAA Chief Counsel Opinion 1989-22, says carrying company officials on a company aircraft must be "incidental to the company's business." If not, an FAA operating certificate issued under part 121 or 135 is required. The FAA issues part 121 certificates to major airlines and part 135 certificates to air taxi/air charter operators.

Obviously, Greenacre Group does not intend to become an airline or charter operator. Therefore, it must either purchase the airplane through a current operating company or set up another entity that has a primary business other than providing air transportation. Any such transportation must be incidental to the entity's main business.

Greenacre decides to outsource all of its marketing, management and event planning functions to a new internal entity called Greenacre Consulting LLC. It will perform bona fide services for the group and any air transportation services will clearly be incidental to its consulting business. The LLC also can render fee-based services to nonrelated businesses. It will not charge Greenacre Group for aircraft use, but will charge consulting, marketing and management fees under contracts with various Greenacre entities.

Since no charges will be made for aircraft use, federal excise taxes will not apply and passive activity classification will not be an issue. Operating the aircraft in this manner will not require an airline or charter certificate.

Planning tip. Don't buy more or less airplane than the company needs. Look for a plane that will satisfy 80% to 90% of your current and anticipated travel requirements for no more than the next three years. (The average ownership period for most business turboprops or jets is about 32 months.)

Planning tip. In Parker v. Commissioner, TC Memo 2002-76, the Tax Court ruled a taxpayer who was active in aviation for more than 34 years was operating as a hobby, in large part because he lacked a business plan. To avoid hobby loss classification, CPAs can help their clients or employers develop a basic business plan for the entity that owns the aircraft.

Now that the entity structure issues are resolved and a travel profile has been developed, Greenacre is ready to select a suitable class of aircraft. Acquisition costs are largely a function of aircraft size and speed. Usually the more you want to carry and the faster and higher you want to fly, the higher the costs.