Tax Reform Considerations for Aircraft Owners

Passage of the Tax Cuts and Jobs Act (TCJA) in late 2017 reshaped the landscape for current and prospective aircraft owners.

Many rules have changed, creating a new patchwork of considerations for those operating an aircraft business or those considering the purchase of an aircraft. This article provides a brief discussion of these changes and other general tax reform measures that may affect a taxpayer’s decision to purchase and/or operate a business aircraft.

Full Expensing for New and Pre-Owned Aircraft

Following passage of the TCJA, taxpayers can immediately write off the cost of new and pre-owned aircrafts acquired and placed in service after September 27, 2017. This write-off provision gradually phases down beginning in 2023 and then expires in 2026. Unlike previous bonus depreciation provisions, the aircraft does not need to be new to be eligible for bonus depreciation. However, a pre-owned aircraft is not eligible for bonus depreciation if it was previously used by either the acquiring taxpayer or a related party. As under prior law, business use requirements must be met for the aircraft to be eligible for depreciation and the normal depreciable period for corporate jets remains five years.

Elimination of Like-Kind Exchange for Aircraft

Aircraft are no longer eligible for tax-deferred like-kind exchange treatment. A transition rule preserves like-kind exchanges of personal property (including aircraft) if the taxpayer has either disposed of the property or acquired replacement property on or before December 31, 2017. Since 100% bonus depreciation is available for new and used aircraft, investing in replacement aircraft often will create new depreciation deductions to offset gain recognized on the sale of an aircraft.

Business Entertainment

Beginning in 2018, all entertainment expenditures are 100% disallowed, regardless of whether they are directly related to a business purpose. Taxpayers can continue to utilize aircraft for business entertainment, but if the primary purpose of the trip is business entertainment, these expenditures will no longer be tax deductible. IRS guidance may be forthcoming regarding how to apply this new rule for trips with multiple activities, some of which include entertainment.

Employee Commuting Expenses

Also beginning in 2018, employers are prohibited from deducting the cost of providing transportation to employees to commute between the employee’s residence and place of employment unless it is necessary for ensuring the safety of the employee. Further guidance is needed to understand what is needed to meet the ensuring the safety of the employee statutory exemption, but prior regulatory guidance suggests that utilizing an aircraft pursuant to an independent security program or other security program provided to an employee on a 24-hour basis would likely qualify for the exemption.

Ticket Tax

The Federal Transportation Excise Tax, or ticket tax, was also amended in the course of tax reform. The amendments clarify that owner flights on managed aircraft are not subject to the ticket tax, but rather are subject to the non-commercial fuel tax. The ticket tax is a substantial excise tax of 7.5% and generally applies to situations where a customer purchases a ticket on a commercial aircraft. However, IRS had taken the position that the tax applies whenever there is a payment or reimbursement for a flight on an aircraft with crew. The TCJA amended the ticket tax so that payments made to a management company by an aircraft owner or qualified lessee for support services on owner flights are generally excluded from the tax.

Interest Expense Limitations

The TCJA also instituted a new limitation on the deductibility of business interest expense. The deduction for business interest expense in excess of business interest income is limited to 30% of the taxpayer’s adjusted taxable income, which is generally taxable income from the business before interest expense, and in years prior to 2022, depreciation and amortization expense. Interest expense deductions that are limited are carried forward to future years where there is excess adjusted taxable income to absorb the interest expense. Although an exception applies to businesses with annual gross receipts under $25 million, a related party aggregation rule applies in determining the amount of gross receipts which may limit the applicability of the exception for many aircraft businesses. Given the fact that aircraft buyers typically incur substantial debt to finance aircraft purchases, the new limits on interest expense deductions will likely have a significant impact on U.S. aircraft buyers, particularly starting in 2022 when adjusted taxable income is not increased for depreciation expense. Leasing rather than purchasing an aircraft may be a better option for some aircraft users since rental expense remains fully deductible.

Special Deduction for Pass-through Business Income

Aircraft business income reported by an individual directly or through pass-through entities may be eligible for a special 20% deduction, which effectively brings the top marginal federal tax rate from 37% to 29.6%. The deduction is generally capped annually based on W-2 wages paid to employees of the business and unadjusted tax basis of qualified property used in the business. For non-corporate owners of aircraft, the business is often managed by independent contractors (e.g., third party servicers) rather than employees. In such case, as there are no W-2 wages, the annual cap would effectively be 2.5% of the original purchase price of depreciable aircraft and other eligible property.

Deferral of Business Losses

The TCJA further created a new excess business loss limitation regime for non-corporate taxpayers, which is in addition to existing rules for passive losses. Specifically, taxpayers other than corporations may not be able to fully offset aggregate net business losses otherwise allowed during the year (active and passive) against other types of income (investment, compensation) as was possible in the past. Excess business losses (e.g., $500,000 or more on a joint tax return) must instead be carried forward and treated as net operating losses (NOLs). The NOL can be used to offset any type of income, effectively creating a one-year loss deferral for taxpayers with sufficient other income to absorb the NOL in the succeeding year. NOLs may be carried forward (not back) and may only be used to offset up to 80% of taxable income in any particular year. Many aircraft businesses have historically been subject to the passive activity loss limitation rules. The new regime now places a hurdle on active losses and may further defer passive losses once they are allowed.

The Takeaway

Current and prospective aircraft owners should review the tax reform changes discussed above to determine the impact on their tax position. Depending on the circumstances, the tax reform changes may have a positive effect on an aircraft owner’s tax position, or may prove costly. Planning and careful structuring with the assistance of a tax advisor who is well versed in the tax reform changes and the nuances of the tax rules as they relate to aircrafts can help to minimize the impact of potentially unfavorable measures.