Is Your Corporate Jet Getting an IRS Audit?

July, 2009

Many high net worth individuals and corporations with jets may face an IRS audit. Issues frequently raised in an IRS audit of corporate jets include whether there is a trade or business, hobby loss and passive activity loss (PAL) and may involve the misinterpretation of the Federal Aviation Regulations (FARs).

Taxpayers may encounter the “trade or business” issue if their entity which owns the aircraft has been leasing the aircraft to them at an artificially low rate. To the IRS, a “trade or business” is an activity primarily conducted for profit. In many cases involving corporate aircraft, the business deductions will exceed business income, resulting in a tax loss. The IRS may argue that no deduction is allowed if the activity is not engaged in for profit. The taxpayer’s response must be based on the facts, so advance planning can be a great benefit if you and your aircraft may face an audit.

An IRS agent may claim that there is no method to generate income from an aircraft without a FAR Part 135 operating certificate. An aircraft owner can lease to other parties for profit within the parameters of FAR Part 91. Knowledge of the interaction of the tax issues with the FARs can be an important factor in responding to any audit questions.

Many corporate aircraft owners lease the aircraft to a charter company to help offset costs, but the owner rarely makes a profit. Any lease of an aircraft frequently triggers an IRS auditor to investigate passive activity loss (PAL) issues. Depending on the facts, a taxpayer may be able to argue that the PAL limitations do not apply if it is ancillary rental of property that is primarily used in the primary trade or business as permitted by IRS regulations. A taxpayer may be able to combine activities and rely on the 2% test or the “Insubstantial Use” test. Depending on the facts, where the rental activity is combined with the primary business activity, a taxpayer may meet the material participation test by virtue of the participation in the primary business activity.

Explaining the complex and varying structuring of the ownership and operation of corporate aircraft to an IRS auditor can be difficult. The use of an attorney experienced in corporate aviation tax and audit issues can help reduce costs and help to ensure the best possible outcome.

Michelle M. Wade and Dillon L. Strohm are attorneys with the law firm of Jackson & Wade, L.L.C. and counsel clients on the acquisition, financing and operation of corporate jets operated under Part 91 and Part 135 of the Federal Aviation Regulations. Jackson &Wade, L.L.C. can be found at www.jetlaw.com.