Avoiding An 800-pound Tax Gorilla

State taxes on airplanes vary greatly around the U.S. The menu of possible charges includes property, excise, and fuel taxes; registration fees; and taxes related to income. Massachusetts is even considering implementation of a $1,000 tax on each general aviation aircraft landing.

But the 800-pound aviation tax gorilla is undoubtedly sales and use tax, where dramatic differences among states exist. If you buy your $40 million business jet in California, you could pay as much as $4 million in state and local sales taxes, whereas if you buy it in Connecticut, you won’t pay a dime. 

Of course, California residents can avoid sales tax on an aircraft purchase by closing the deal in a state that doesn’t tax such transactions. That’s one reason why states with a sales tax impose a “compensatory” use tax on airplanes that, though purchased outside their borders, are eventually used or stored within them.

Jets pose a special state tax challenge since they are highly mobile and designed for long-distance travel: they can potentially be “used” in all 50 states, and some of them are. Does this mean states with a use tax on aircraft can impose it on every aircraft that lands (and is therefore “used”) there?

Not even tax laws are that crazy—or are they? As interpreted by the U.S. Supreme Court, the U.S. Constitution (especially the commerce clause and the right to due process of law) limits the ability of states to impose taxes on interstate commerce. The Supreme Court, however, has waffled in its interpretations regarding taxation of movable property like airplanes. 

For a while, it deployed the so-called taxable moment theory, according to which property “in transit” could not be taxed until it had “come to rest within a state.” The problem with airplanes is that they are notoriously restless and may be constantly circulating in interstate commerce. The Supreme Court dealt with this conundrum by appealing to an old common-law rule called the “home port doctrine,” according to which the aircraft was deemed to “come to rest” (and effectively don a sign saying “tax me”) at its home base or port.

The airplanes may come to rest, but the law did not. In 1943, the Supreme Court let Minnesota tax Northwest Airlines’ entire fleet of commercial aircraft because St. Paul, Minnesota, was deemed the “home port,” but a few years later, the court upheld a Nebraska property tax on the Braniff Airways fleet (even though it was based outside that state) on the theory that the airline’s regular contact with Nebraska (18 stops per day) provided sufficient “nexus” (a Latin word that means “connection”) to the state to justify the tax. 

Eventually, in Complete Auto Transit v. Brady (1977), the court replaced both the taxable moment theory and the home port doctrine with a four-part test. A state tax on an interstate business activity must (1) be applied to an activity with substantial nexus to the state, (2) be fairly apportioned, (3) not discriminate against interstate commerce, and (4) be fairly related to the services provided by the state. These tests remain the basis for the law today.

Though all four standards are important, the key test for business jets is “substantial nexus.” You don’t even get to “fair apportionment” or “discrimination against interstate commerce” if the state can’t establish a substantial connection to the aircraft or its owner sufficient to justify a tax. Having the aircraft based in the state (its “situs,” the equivalent of a taxpayer’s “residence”) pretty much settles the nexus question, but cash-hungry states work hard to establish enough nexus to impose use, excise, and even property taxes on business and commercial jets based elsewhere.

A key criterion of substantial nexus is physical presence, and courts have traditionally held that the absence of physical presence ruled out substantial nexus. At various times, states have argued the converse: that if the aircraft does have physical presence in the state, it must therefore have nexus. States have also proposed that simply flying over the state should constitute sufficient grounds to justify a tax. More recently, a state successfully argued that physical presence isn’t required at all for taxing out-of-state vendors and that a convenient new concept called “economic nexus” offers sufficient justification for sales tax levies.

Thus, in South Dakota v. Wayfair Inc. (2018), the Supreme Court sanctioned state taxation of e-commerce businesses with no physical presence in the state. States were quick to take advantage of the ruling. Oregon, for example, enacted a gross receipts tax that took effect on Jan. 1, 2020, claiming substantial nexus (with no physical presence required) based on how much money businesses receive from Oregon customers. A state like Oregon that establishes an aircraft owner's substantial "economic nexus" may thus try to impose use tax on an aircraft that lands there.

Meanwhile, jet owners concoct their own schemes to avoid nexus as well. A common plan for owners who reside in a high-tax state is to base the aircraft in a nearby low-tax or no-tax state. If the owner drives to meet the aircraft in the low-tax state, that might work, but if the jet regularly positions to the high-tax state to pick the owner up, an argument against the state’s ability to impose use tax may prove unconvincing. It could also be expensive. California imposes a 50 percent penalty on aircraft owners who try to avoid use tax by registering their aircraft outside the state. 

In addition to how often an aircraft lands in a state, it makes a difference when an aircraft lands there. Florida, for example, exempts non-residents from use tax on their aircraft if they spend no more than 20 days in the state during the six months following its purchase. (Again, residents of the state presumably aren’t entitled to the exemption because residence itself constitutes substantial nexus.) 

Similarly, in 2014, the Nevada Supreme Court held that Harrah’s forfeited the benefit of a Nevada rebuttable presumption that two jets purchased out-of-state by the casino were acquired for use in interstate commerce because their first flights (with passengers on board) were directly into Nevada. On the other hand, the court held that two other jets that had their first trip outside Nevada still enjoyed the benefit of the presumption. 

In California, even if the first flight is elsewhere, if you fly into the state during the first year you own the aircraft, there is a rebuttable presumption that you purchased it for use in California when certain other conditions are satisfied. The lesson is that if you plan to travel to a state a lot or have some material connection with it, make sure you figure out its use tax rules before flying into it. That’s especially true for your first flight, where it may be hard to argue that you didn’t buy the aircraft with the intent to use it in a state when it’s the first place you go. 

What can you do about substantial nexus in high-taxing states? First, don’t think that incorporating your aircraft-owning company in, say, Delaware will help you to avoid taxes. It won’t. The state of formation or incorporation of the entity owning the aircraft is basically irrelevant to nexus. It’s better to focus on where to base the aircraft. 

There’s a good argument that the aircraft’s “situs” should be where you are—where your residence, assets, and company are located. Basing, registering, and hangaring the aircraft in that state helps protect against taxes from states with little claim on you. 

However, if you reside in a high-tax state and can’t take advantage of any exemption from tax, it may make sense to base the aircraft elsewhere, assuming you can keep its contacts with your state to a minimum. In certain states, you may only need to do this for a limited period. Some states offer other options, such as paying sales tax on lease payments. And before pointing your aircraft toward a state like California or Florida, make sure you understand the rules—and consequences—of flying into the state at all.

 

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From Zilch to Four Million

Maximum state and local sales taxes on a $40 million aircraft purchase vary greatly, as you can see from these examples.

Oklahoma: $4.4 million

California: $4 million

Iowa: $2.8 million

North Carolina: $2,500

South Carolina: $500

Massachusetts: $0

Source: National Business Aviation Association State Aviation Tax Report