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Weighing Your Options: How to Choose the Right Aircraft Ownership Structure
Whether you’re using an airplane for business for the first time or have managed an airplane for years, one of the toughest challenges is choosing the right aircraft ownership structure. There are about as many unique structures as there are operators. Part of what makes choosing the right one so complicated is that the decision affects nearly every other challenge of business flying: operational flexibility, regulatory compliance, taxes and liability.
The first step is deciding whether to operate under FAR Part 91 or Part 135.
“If you want to operate under Part 91, the general rule is you cannot receive compensation for air transportation,” said Gary Garofalo, a partner at aviation law firm Garofalo Goerlich Hainbach PC and a member of NBAA’s Tax Committee. “The Federal Aviation Regulations [FARs] list about nine exceptions to that rule. If you have a plan for being compensated for usage, the first question you need to ask is: Does your plan fit under any of those exceptions?”
Some of the more commonly used exceptions are: chargebacks for flights incidental to and within the scope of the operator’s business, dry leases, operations under Part 91 Subpart F, and in certain cases, for fractional ownership programs under Part 91 Subpart K (see “Common Ownership Structures”). NBAA provides an online guide to these ownership options at www.nbaa.org/admin/options.
NBAA Tax Committee members weighed some of the most important considerations for adopting various ownership structures. Their insights here are merely an overview, not a comprehensive analysis, and don’t go into every issue, like Securities and Exchange Commission (SEC) reporting.
Five Basic Considerations
“There’s a drawback to every structure,” said John Hoover, also a Tax Committee member and senior counsel at aviation law firm Dow Lohnes PLL C. Deciding which ownership structure to put in place is about balancing compliance with the FARs against all the other demands of your business. Tax Committee member Jeff Wieand, senior vice president at Boston JetSearch, breaks these down to five considerations:
- FAA compliance – Complying with the FARs isn’t optional, but some structures create a greater risk of
violating the Part 91 prohibition against charging for flights. For example, under the corporate services
company structure, there’s a risk the FAA will interpret the management fees paid to the corporate services company
as payment for transportation services.
The most common way businesses run afoul of the FARs is by creating a separate entity that owns and operates the airplane, and is reimbursed for it. “The FAA takes the ownership structure you put together very seriously,” said Wieand. “If you create a separate entity to own the airplane, they’re going to look very closely at that entity.”
- Liability – Due to the nature of aircraft operations, there’s a potential for significant liabilities in operating an airplane. Under Part 91, the operator is responsible for safe operations and compliance with FAA regulations. There’s also
a second kind of liability associated with just being the owner of an airplane, even if you are not the operator. “You can limit some liability by putting the airplane on a Part 135 certificate, but then you have to pay federal excise tax (FET) on all Part 135 flights,” said Wieand.
- State sales and use tax – Sales and use tax can significantly increase the initial purchase cost of a business
airplane. Several states with a sales tax provide a general exemption for aircraft; others, including New York
and California, do not. Some states do offer resale and commercial-use sales tax exceptions, in different forms.
By putting the airplane on a Part 135 certificate, operators in some states can take advantage of commercial-use
There are trade-offs everywhere you turn. Rarely can you get an optimal solution for each issue. Jeff Wieand Senior Vice President, Boston JetSearch
A dry lease is a common ownership structure used to take advantage of resale exemptions, as opposed to incurring a large one-time tax bill. Under a resale exemption, sales tax is charged on final products and services. By putting the airplane into an aircraft company that leases the airplane to the business, sales tax is instead due on the annual lease payments. “A dry lease may lower your tax bill, unless you hang onto the aircraft for a long time,” said Hoover. “These planes last up to 30 years, and the sales tax on those lease payments add up.” The state could, in fact, receive more sales tax revenue. The real benefit of a resale exemption is that the sales tax is paid over time, not all at once the day you purchase the airplane.
- Federal tax deductions and FET – Every operator wants to minimize the amount of FET they pay and maximize the federal tax deductions they can take for the cost of flying an airplane for business. Some structures, such as time sharing and interchange agreements, involve some FET assessment; others, like a corpoate services company or accountable plan, create
a greater risk of FET being assessed if the Internal Revenue Service (IRS) determines the management fees or expense reimbursements are payments for air transportation services.
FET generally is not assessed on chargebacks or dry lease payments, so the structures best suited for avoiding FET are the consolidated group or a dry lease.
The restrictions on deducting the cost of operating the aircraft from the business’s taxable income – beyond the entertainment disallowance – are mostly based on the IRS’s passiveloss and hobby-loss rules.
“The passive-loss rules prevent the deduction of net losses from passive activities like leasing or any separate activity that doesn’t require full-time work,” said Hoover. “In a dry lease, where the airplane is owned in a separate entity, it must be used in the service of the enterprise to be grouped as one economic unit with the business. If it’s appropriate to group, you can deduct the losses from the aircraft company.”
A better-known restriction, the hobby-loss rules, limit the amount of deductions from activities that are not engaged in for profit. “A lot of times, the entity that owns the airplane is not being conducted for profit,” said Hoover. “However, the business is still using the airplane to improve its profits. It would be like telling a national retailer that its trucks are not being operated for profit if the trucks are held in a separate subsidiary.” In order to take a deduction, you often have to group the airplane with the business operated for profit. To do that, you may have to demonstrate the airplane is used in that business.
- The realities of your business – The final consideration is the one that makes all the difference: the realities
of how you already run and have legally structured your business. If your business and your airplane are based in a state with no sales tax, it will be less of a consideration. If you want to share an aircraft with another business, the exceptions in Subpart F and Subpart K might be the best fit.
“There are trade-offs everywhere you turn,” said Wieand. “Rarely can you get an optimal solution for each issue: compliance, liability, sales tax, FET. Sometimes, for instance, you decide to take on a little more FET to reduce state tax liability.”
The consolidated group is the simplest structure, but not a good fit for separately owned companies seeking to share an airplane. “When the business is already structured with multiple separately owned companies receiving services from a single company, then the corporate services company structure fits,” said Hoover, “but if your separately owned businesses operate and are managed independently, then placing an aircraft into a newly created corporate services company may look contrived.”
When deciding how to structure the ownership of your business aircraft, Tax Committee members strongly recommend consulting an aviation attorney, and finally, filing the necessary paperwork.
“Once you’ve decided on a structure, you have to document it,” said Garofalo. “For example, time sharing is a wet lease. The truth-in-leasing rules in the FARs require filing a copy of the lease with the FAA and keeping a copy on the aircraft. Interchange agreements also have to be filed with the FAA.”
NBAA Tax Committee members summarized some of the most common business aircraft ownership structures discussed in this article.
None of these ownership structures require an internal flight department. Under any ownership structure, the airplane can be crewed and maintained by an aircraft management company. Under several structures it’s also possible to lease the airplane to an aircraft management company for charter in order to recoup some of the costs of ownership. However, this part-time charter arrangement presents certain federal tax risks, from FET to passive-loss and hobby-loss rules.
Some of the most common aircraft ownership structures are:
- Consolidated Group
Under this structure, one company owns the airplane, employs the pilots and provides flights for its business and the business of other companies within a consolidated group (i.e., companies that are ultimately owned by a single company). This is the simplest structure, especially from the point of view of FAA compliance and federal tax deductions. The FARs allow chargebacks within a consolidated corporate group, and the business can deduct the full cost of nonpersonal flights. However, sales tax may be due on the full value of the airplane at the time of purchase. This structure also may expose the business to a greater level of liability than others.
- Dry Lease
In states with a high sales tax, a common tax-planning method is to acquire the airplane in a leasing company that dry leases the airplane to the business. Sales tax is then assessed on the annual lease payments to the leasing company, which often operates at a loss. To avoid violating passive-loss and hobby-loss rules, a large percentage of the flights should be for the business of the lessee.
- Corporate Services Company
Many companies that rely on business aircraft conduct their business through multiple companies that are separately owned, like car dealerships, nursing homes or drilling sites. Often a single corporate services company provides accounting, legal, human resources and other services, as well as executive management, to the other companies in return for a management services fee. Under this structure, the airplane is owned and operated by the corporate services company, and the management fees paid to that entity by the others cover its costs, including the cost of operating the aircraft. For some businesses this is a very natural structure, but it could raise FAA compliance concerns, especially if the corporate services company transports employees of the separate companies and line items in the management services fees are directly related to the specific employee flights.
- Accountable Plan
A method allowed by the IRS for reimbursing employees for travel expenses, an accountable plan is a fairly common method for reimbursing an employee, who is an aircraft owner/operator, for business travel aboard his own airplane. However, there is no Part 91 exception for travel expense reimbursement, so this structure raises FAA compliance concerns. In the absence of a dry lease, sales and use tax may be due upon the acquisition of the aircraft.
- Time Sharing, Interchange and Joint Ownership
FAR 91.501 (Subpart F) applies to large (more than 12,500 pounds maximum takeoff weight) or multi-engine turbojet fixed-wing airplanes of U.S. registry. NBAA has also obtained an exemption, exclusively for its Members that operate small aircraft and helicopters, to take advantage of the options in FAR 91.501. Subpart F permits limited compensation for flights in about nine specific exceptions. Some of these are very specialized, such as exceptions for aerial photography and demo flights. The most commonly used exceptions under Subpart F are:
- Time sharing – This is a wet lease of an airplane with at least one crewmember, and it is the simplest way to charge people outside your company for use of your aircraft. Compensation is limited to certain operating expenses and twice the cost of fuel. FET is due on the amount paid.
- Interchange agreement – Two companies swap wet leases, trading time on one company’s aircraft for time on the other. If one company’s airplane is more expensive to own, operate and maintain, the other company can compensate for this difference in value, but not for a difference in the number of hours flown. FET is due on the amount paid, including the value of the flights exchanged.
- Joint ownership – An airplane is co-owned by at least two companies. One of the joint owners furnishes the crew and operates the airplane, and the other joint owners compensate that company. To ensure FAA compliance, each company’s ownership share should approximately correspond to its share of the aircraft use.
- Fractional Ownership
Fractional programs may be conducted under Part 135 or Part 91.1001 (Subpart K). In a fractional program, several co-owners dry lease their airplanes to each other and hire the same aircraft management company. The arrangement must involve more than one airplane, and each owner’s share must be at least 1/16 of the aircraft. In a traditional fractional ownership program, the owner is the operator and the aircraft management company is a service provider, even though “licensed” by FAA under Subpart K. Alternatively, the owner may opt for the management company to be the operator (assuming the management company has the requisite FAA Part 135 certificate).
For More Information
Get guidance on how to avoid the “flight department company” trap in this edition's “Ask the OSG”.
Read a previous article in the Nov/Dec 2010 issue of Business Aviation Insider, titled “Should You ManageYour Flight Department Under Part 91 or Part 135? What You Need to Know to Make the Choice.”
To learn more about aircraft operating & ownership options, visit www.nbaa.org/admin/options.