Don’t miss out on valuable business tax write-offs
We often hear the following statement from business owners who use their aircraft to travel for business purposes, “my accountant said not to deduct the costs of the airplane.” Why wouldn’t you deduct the associated costs if you used your aircraft for business? Would your CPA say the same thing about any piece of machinery or equipment that you use in your business? Truly, we understand the sentiment of their professional’s concern since they are trying to reduce the risk of exposure to a potential audit by the IRS. There is definitely an element of risk tolerance built into the decision to put an aircraft on a tax return so let’s look at how we can reduce that risk.
Know what you’re doing
If you’ve formed a company to own the aircraft, such an LLC, a partnership, or a ‘C’ or ‘S’ corporation, you undoubtedly realize the level of recordkeeping and financial reporting has increased. You have to properly report the ownership to the FAA, your insurance company and report the information on a tax return, and it only makes sense that you will report your business use of the aircraft on the associated tax return. If you use the aircraft for business, even a small percentage of the time, you will have to contend with tracking both the business and personal use of the aircraft to properly reflect the amount of expenses resulting from business use on a tax return.
Forming a company and registering that company as the owner with the FAA does not automatically make the costs associated with the aircraft deductible on your tax return. You still need to show there is business use of the aircraft, that is, the aircraft was used in a business or as part of a group of activities that, together, have a profit motive.
Instead, if you owned the aircraft personally, that doesn’t leave you out of taking a deduction for the business use of the aircraft. Owning the aircraft personally and showing the business-related costs on your individual tax return is a bit more complicated. The IRS expects to see a business own or lease all of its assets and those assets will appear on the tax return. When an individual owns the asset, the expenses and other costs, such as depreciation need to be reported on the individual’s tax return where it will have higher visibility than if it were shown on a business tax return where other expenses and depreciation will already be present. For example, twenty-five thousand dollars in depreciation deduction on a business tax return will likely not be obvious, but this same deduction on a personal tax return may stand out.
Likely, you may have an arrangement for the costs to be reimbursed from an associated company, but be beware of FAA rules that limit the amount which can be reimbursed and DOT rules which could interpret the reimbursement as if you were running your own airline, without the required license. Careful planning is critical, either before the purchase of an aircraft for business use or the transition of an aircraft from personal to business use, to ensure your successful navigation through IRS, FAA and DOT regulations.
Ordinary and necessary requirements
Before using your aircraft for business purposes and ultimately deducting the costs associated with that use, look at the reasonableness of using the aircraft in your business. As an example, our firm worked on an IRS audit where the aircraft owner deducted business related costs but the IRS denied the deductions because his business sites were all located within a fifty mile range of each other. There was an occasional trip to a supplier, customer or convention which were totally legitimate business expenses, but these deductions were dwarfed by the costs of operations for the rest of the year. These costs were not incidental to the business, which is a key factor in showing an expense was ordinary and necessary for the business.
Typically, we need to prove three things; air transportation is required, air transportation may only be met by private aircraft, and the aircraft used is appropriate in meeting the transportation needs of the company. If you are a plumbing contractor operating within a small geographic area, the ordinary and necessary test will be more difficult to overcome, as opposed to a plumbing contractor who has jobs over a tri-state area.
What can you legitimately deduct?
Generally, we can deduct the fixed costs associated with the ownership of the airplane, such as insurance, hangar rent, licensing fees, subscriptions, and loan interest, as well as the direct operating costs of fuel, oil, supplies and maintenance. The most costly expense of an aircraft is deprecation, a non-cash expense, which is allowed for assets used in a trade or business.
Keeping track of those costs throughout the year is not difficult, but is a function of the size of the aircraft and number of hours of operation per year. Simple operations can be tracked on a dedicated credit card while more complex operations will want to formalize their recordkeeping by using QuickBooks or some other accounting software. We have had great success using QuickBooks Online with customers who want to outsource the accounting and billpaying for their aircraft. This tool gives everyone online visibility into the records of the aircraft. It also helps when it comes to tax return preparation since much of the work has been done throughout the year.
Where the accounting and tax information comes together is the business use of the aircraft. You have to have a way to determine which hours of operation were for business and which were for personal use. On the surface, this task may not seem that difficult, but if the recordkeeping of the flights and purpose of the flights is not maintained throughout the year, it can be a challenge to catch-up. IRS rules dictate recordkeeping of ‘listed’ assets (assets identified by the IRS as being prone to abuse such as aircraft) by increasing the recordkeeping criteria to ‘contemporaneous’ (records need to show the purpose of each flight and the purpose of each passenger.) The desired result, for use by your tax preparer, will be a log showing the amount of business use and personal use for the calendar year. The percentage of business use will be applied to the deductible expenses for the year for presentation on a tax return.
You can, and should, deduct aircraft expenses associated with the business use of your aircraft. By proper planning and recordkeeping you mitigate the risks of the IRS denying deductibility of these expenses if they were ever challenged. There is a higher level of recordkeeping that you need to be prepared for, but that shouldn’t stop you from taking legitimate deductions. Challenge the advice from professionals who would prefer not to deal with aircraft and be wary of advice from your hangar-neighbors and flying buddies who deduct everything associated with their aircraft. After all, their tax and business structure situation may not be the same as yours. But, you don’t get extra points with the IRS by not deducting expenses, so take advantage of the deductions that you are allowed to take.
Sue Folkringa is a licensed Certified Public Accountant, MTax, ATP with Wolcott & Associates, P.A.