NBAA 5-3-13 Maximizing Business Deductions While …€¦ · BusinessAviation Taxes Seminar | Washington,DC | May 3, 2013 Friday, May 3, ... P.C. 2013 Disclaimers • This presentation

Maximizing BusinessDeductions While AvoidingTrouble

PRESENTED BY:Keith G. Swirsky, Esq.GKG Law, P.C.1054 31st Street N.W., Suite 200Washington, DC 20007Tel: (202) 342-5251Fax: (202) 965-5725Email: [email protected]

Business Aviation Taxes Seminar | Washington, DC | May 3, 2013

Friday, May 3, 2013 | 8:45 a.m. – 10:00 a.m.

2Copyright GKG Law, P.C. 2013

Disclaimers

• This presentation is being provided for general informationand should not be construed as legal advice or legal opinionon any specific facts or circumstances. You are urged toconsult your attorney or other advisor concerning your ownsituation and for any specific legal question you may have.

• IRS CIRCULAR 230 DISCLOSURE - To ensure compliancewith requirements imposed by the IRS, we inform you that anyU.S. tax advice contained in this communication is notintended or written to be used, and cannot be used, for thepurpose of (i) avoiding penalties under the Internal RevenueCode or (ii) promoting, marketing or recommending to anotherparty any transaction or matter addressed herein.


Aircraft Operating Expense Deductions

Trade or Business Expenses (IRC 162)

Expenses of an activity (including expenses inexcess of revenue) are only deductible if:

• the activity is a trade or business activity, and

• the expenses are ordinary, necessary, andreasonable


Aircraft Operating Expense Deductions

Activities Not Engaged in for Profit (IRC 183)

• Also known as the “Hobby Loss” rules

• Ordinary, necessary, and reasonableexpenses of an activity are deductible only upto an amount equal to the income producedby the activity


Depreciation Deductions

(IRC 167-168)

In addition to aircraft operating expensedeductions, the Tax Code allows a deduction forexhaustion, ordinary wear and tear andobsolescence of property used in a trade orbusiness or held for the production of income

This deduction is known as “depreciation”


Depreciation DeductionsThe Applicable Recovery Period

• Asset Class 00.21:

– Airplanes (airframes and engines) except those usedin commercial or contract carrying of passengers orfreight, and all helicopters (airframes and engines),(e.g., “Corporate Aircraft” and helicopters)

– Six Year Class Life

– Five Year Recovery Period (MACRS)

– Six Year Recovery Period (Straight-Line - ADS)

ASSET CLASS 00.21 – APPLICABLE PERCENTAGES(Half-Year Convention)

Year Percentage Deduction

5 Year Property 6 Year Property

1 20.00% 8.333%

2 32.00% 16.667%

3 19.20% 16.667%

4 11.52% 16.667%

5 11.52% 16.667%

6 5.76% 16.667%

7 - 8.333%



• Asset Class 45.0:

– Air Transport: Includes assets (except helicopters)used in commercial and contract carrying ofpassengers and freight by air, (e.g., commercial andcharter aircraft).

– Twelve Year Class Life

– Seven Year Recovery Period (MACRS)

– Twelve Year Recovery Period (Straight-Line - ADS)

Year Percentage Deduction

7 Year Property 12 Year Property

1 14.29% 4.167%

2 24.49% 8.333%

3 17.49% 8.333%

4 12.49% 8.333%

5 8.93% 8.333%

6 8.92% 8.333%

7 8.93% 8.333%

8 4.46% 8.333%

9-12 - 8.333%

13 - 4.167%

ASSET CLASS 45.0 – APPLICABLE PERCENTAGES(Half-Year Convention)



• If the aircraft is used part of the time in commercialcarrying of passengers and freight (i.e., asset class45.0), and part of the time for other purposes (i.e.,asset class 00.21), the aircraft should be depreciatedaccording to its primary use

• A change in the primary use of the aircraft after theyear in which the aircraft was placed in service willresult in a retroactive change in the depreciationmethod if the primary use was non-commercial, andsuch use changes to become commercial use


Qualified Business Use

• 50% Test:

– To qualify for MACRS, more than 50% of the use ofthe aircraft must be Qualified Business Use

• Qualified Business Use is use in a trade or business of thetaxpayer

• 25% Test:

– Three categories of uses only qualify as “QualifiedBusiness Use” if all other Qualified Business Usescomprise at least 25% of the total use



• The Three Categories of Excluded Uses:

– Leasing of aircraft to any person who owns 5% or more ofthe taxpayer, or to any related person (within the meaningof Section 267(b) of the IRC);

– Use of the aircraft to provide compensation to any personwho owns 5% or more of the company, or to any relatedperson;

– Use of the aircraft to provide compensation to any otherperson, unless an amount is included in the gross incomeof such person with respect to such use of the aircraft, andany required income tax was withheld (e.g., SIFL)



• The 25% and 50% use tests must be met duringevery taxable year that the aircraft is in service

• If an aircraft depreciated under MACRS duringany taxable year fails the 50% test in asubsequent year, the taxpayer must recaptureprior depreciation to the extent that depreciationdeductions taken during prior years exceed thedeductions that would have been allowed underthe ADS system


Qualified Business Use:Leasing Company Trap

• CAUTION!

• TAM 200945037:

– IRS interpreted 280F to exclude all use of an aircraftthat is leased to a 5%owner or related person frombeing used to meet the 25% test regardless ofwhether such use was for business or personalpurposes; provided, that use of the aircraft by one ormore other persons (i.e. not 5% owners or relatedpersons) may count as qualified business use


Entertainment, Recreation and Amusement

(IRC 274)

• limits deductions for expenses of facilities(including aircraft) used for entertainment,amusement or recreational purposes


Entertainment, Recreation andAmusement

• Expenses for entertainment, amusement, andrecreational flights of “Specified Individuals”are deductible only up to the amount ofincome imputed to (or reimbursementreceived from) the Specified Individuals



• The term “Specified Individuals” includes allofficers, directors and persons directly orindirectly owning more than 10% of any equityclass of the taxpayer, or any related party (withinthe meaning of IRC §§ 267(b) or 707(b))

– Applies to private companies, publicly-held companies,partnerships, and tax-exempt entities

– Includes spouse, family members or guests of thespecified individual



• Law does not impact deductibility of expensesattributable to travel of Specified Individualsfor business purposes, or for personal non-recreational purposes

• Law does not impact deductibility of expensesattributable to travel of Non-SpecifiedIndividuals for any purposes, includingrecreational purposes



What is Entertainment, Recreation or Amusement?

• Sports events

• Hunting

• Fishing

• Golfing

• Travel to Country Clubs

• Skiing

• Resort Destinations



What activities are personal, but not Entertainment,Recreation or Amusement?

• Commuting

• Travel to a funeral

• Travel to for medical purposes

• Travel for charity work

• Travel for business other than that of the employer providing theflight

• Travel to meetings with personal advisors

• Transportation between homes not associated with entertainment



• IRS issued Final Regulations relating to use ofaircraft for entertainment, recreation oramusement, effective for tax years beginningafter August 1, 2012

• Final Regulations, and Strategies toAvoid/Minimize disallowances under IRC 274,will be discussed in greater detail by JedWolcott this afternoon


Basis and At Risk Rules Under IRC 465

• Losses relating to an activity engaged in by anindividual in carrying on a trade or business orfor the production of income are allowed asdeductions only to the extent that the individualis at risk financially with respect to that activity



• Generally the individual is considered to be atrisk financially by one of the following:

– Contributing money to the activity in question

– Pledging property other than the property used in theactivity as security for the debt

– Being personally liable for repayment of third-partydebt obligations relating to the activity



• To be considered personally liable for repaymentof third-party debt obligations:

– The individual must be ultimately and personally liableto repay the obligation (obligor of last resort) whenfunds from the investment activity are not available

– Other investors or participants who remain in thechain of liability do not detract from the at-risk amountof investors who have the ultimate liability

– The individual must be primarily rather thansecondarily liable for repayment of the third-party debt



• The following would NOT place the individual atrisk:

– Non-recourse financing

– Stop loss agreements

– Contingent liability

• A personal guaranty may place the individual atrisk

– Facts & circumstances analysis

– For S corporations, basis is not increased



• Any disallowed loss is carried forwardindefinitely to the individual’s next succeedingtax year until the deduction of such loss is nolonger limited


Passive Loss Rules under IRC 469

• Overview of Section 469: Why is Section 469Important?

– Depreciation and operating expense deductions mayhave little or no tax benefit:

• Annual netting

• Suspension of excess passive activity losses.

• Carry forward until interest disposed

• Results in deferral of losses that could be used to offsetincome from other sources.



• Applicability:

– Individuals

– Partnerships, LLCs

– S Corporations

– Closely Held C Corporations• Five or fewer own > 50% of stock, directly or indirectly

• Passive losses can be used to offset operational income, notportfolio income



• Applicability (cont.)

– Personal Service Corporation:• Principal activity is performing personal services, e.g.

medicine, law, engineering, architecture, accounting,performing arts, consulting

• Services are substantially performed by employee-owners,i.e. greater than 20% of the compensation cost to thecorporation is attributable to employee-owners

• Employee-owners own more than 10% of the fair marketvalue of the stock



• Types of Passive Activities

– Business activities in which the Taxpayer does not“Materially Participate”

– Rental activities



• Material Participation Tests:

– 500 hour rule (safe harbor rule)– Substantially all rule– 100 hours and not less than the participation of

any other individual– Participation in all significant participation activities

(SPAs) greater than 500 hours– Prior material participation (any 5 years in past 10

years)– Personal service activities– Facts and circumstances



• Rental Activities:

– An activity is a rental activity if gross incomeattributable to the activity represents amounts paidprincipally for the use of property

– A rental activity is considered passive regardless ofwhether the taxpayer materially participates in theactivity, unless an exception applies



• Exceptions to per se passive classification of rentalactivities:

– < 7 day rentals– < 30 day rentals, and “significant” personal services are

also provided– “Extraordinary” personal services, e.g. transportation

services– Providing aircraft to an LLC, partnership, or S corporation

in the taxpayer’s capacity as an owner– Rentals “incidental” to a trade or business or investment

activity



• For aircraft used in a trade or business,“incidental” means:– The taxpayer owns an interest in the business,– Aircraft is used predominantly in the business, AND– Gross rental income is < 2% of the cost basis (or FMV

if lower) of the aircraft• For aircraft held for investment, “incidental”

means:– Principal purpose of owning the aircraft is to

realize gain from appreciation, AND– Gross rental income is < 2% of the cost basis (or

FMV if lower) of the aircraft



• Use of Single-Member LLC’s and QSSS’s toAvoid Rental Characterization

• Grouping of Activities to Avoid RentalCharacterization:– Applies When Taxpayer Owns Multiple LLC’s, S

Corporations, or Partnerships, e.g. an S Corporationand an aircraft owning LLC

– Activities Owned Through One Entity, e.g. the LLC,Can Sometimes Be Grouped With Activities OwnedThrough Another Entity, e.g. the S Corporation

– Activities Owned Through C Corporations Cannot BeGrouped



• Activities being grouped must form an appropriateeconomic unit.

• Facts and Circumstances test

• Factors to be considered in facts and circumstances testinclude:

– Similarities/differences in types of trades or businesses– Extent of common control– Extent of common ownership– Geographical location– Interdependencies, e.g. inter-company sales,

complementary products, same customers, sameemployees, same set of books and records

Closing Remarks

Keith G. Swirsky, Esq.GKG Law, P.C.

1054 31st Street N.W., Suite 200Washington, DC 20007

Tel: (202) 342-5251Fax: (202) 965-5725

[email protected]

NBAA 5-3-13 Maximizing Business Deductions While …€¦ · BusinessAviation Taxes Seminar | Washington,DC | May 3, 2013 Friday, May 3, ... P.C. 2013 Disclaimers • This presentation

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