Running an IRS gauntlet

Suppose you live in San Francisco and own a fast-food franchise in Baltimore. To make sure the business is running properly, you visit it from time to time, flying in on your Global 6000. 

To be deductible for tax purposes, these travel costs—and any business jet expense—must run a gauntlet of IRS requirements. For one thing, they should be related and helpful to the business; and the flights to Baltimore may qualify on that ground. But they should also represent “ordinary and necessary” expenses, not lavish indulgences, and this criterion can present a problem for jet owners. A single fast-food franchise does not—and never will—generate enough profit for visiting it in a Global 6000 to make business sense. As such, the IRS might disallow the expenses, or at least reduce them to an amount it deems reasonable, like the cost of airline tickets.

The case could be different for a business that doesn’t make much money today but has the potential for earning Global 6000-size profits. In that situation, the IRS might deem the expense reasonable.

Another circumstance that could make business jet travel justifiable to the IRS might be the need to travel to places that commercial aviation doesn’t serve. It also helps if use of a corporate jet is “normal, usual, or customary” in the line of business. Many professional sports team owners, for example, fly to games in private jets, so if you own a struggling pro football team you’re likely on better ground to justify your business-related private jet travel deductions than if you own a wildly successful nail salon.

All this can seem like common sense, but many taxpayers run into trouble anyway. A 2015 Tax Court case concerned a personal-injury attorney-pilot in the Los Angeles area who purchased a single-engine Cessna Turbo Skylane. During the following two years, he logged about 275 hours on the aircraft, approximately two-thirds of which were to destinations within 100 miles of his home, and some of which were as little as 30 miles away. The attorney deducted his expenses for all of these flights, including those that he claimed were for “maintenance”; for obtaining an instrument rating; and for travel to Palm Springs, a mountain resort community, his parents’ home in North Dakota, and meetings of a pilots’ association “to discuss complaints about the price of aviation fuel.” As the court noted, the evidence established that the attorney “immensely enjoys flying.”

The court also determined that the taxpayer bears the burden of establishing that expenses are ordinary and necessary. The attorney apparently hoped that the notoriously horrific Los Angeles traffic conditions would provide an ample argument for flying instead of driving, but the Tax Court said a “powerful argument” could be advanced against allowing a tax deduction for any of the expenses. 

“The cost of owning and operating a private airplane,” said the court, “would not appear to be ‘normal, usual, and customary’ for an attorney in solo practice, especially one who makes 60 to 65 percent of his flights to destinations within 100 miles of his home.” The court also expressed skepticism about the reasonableness of spending as much as $433 per flight hour to travel to destinations you can drive to in less than an hour.

In the end, the court allowed the deduction of a small portion of the flight expenses that had not been contested by the revenue agents on audit, disallowed the use of accelerated depreciation of the aircraft, and permitted depreciation deductions only to the extent of the deemed business flights.

The IRS not only requires that flights have a business purpose and that the expenses be ordinary and necessary; it also requires the taxpayer to demonstrate this by maintaining adequate and contemporaneous records. A 2014 Tax Court case, this one concerning a law firm that had been involved in the Erin Brockovich litigation against Pacific Gas and Electric, underscores this stipulation. Walter Lack, a 50 percent partner of the law firm, shared ownership with Thomas Girardi, another personal-injury lawyer unrelated to the firm, in a company called G&L Aviation, which in turn owned a Gulfstream GIV jet and a King Air turboprop. The law firm had no interest in G&L, but nevertheless deducted costs of operating the aircraft against its income.

The catalog of mistakes made by this firm is astonishing. No leases or other written agreements existed between it and G&L Aviation to show that the law firm was using or paying for flights (a serious FAA issue as well). For many flights, the firm didn’t even pay the expenses; instead Lack paid for them directly, later asserting that he did so on the law firm’s behalf, though the firm apparently never recorded the amounts as capital contributions. The law firm also claimed deductions for flights by Girardi even though he had no connection to the firm, and for flights by Lack that appeared to have no business purpose.

G&L did keep records of payments received for the air travel. But in the absence of contemporaneous data showing “flight information, passengers, or the purposes of flights,” the law firm attempted to satisfy IRS requirements by furnishing reconstructed records. [See “Surviving a Tax Audit,” in our June/July 2012 issue.—Ed.]

The results were predictable. The IRS argued that many expenses weren’t ordinary and necessary because the amounts weren’t reasonable, and it said other deductions couldn’t be justified as business expenses at all. 

The court was “disinclined to embrace after-the-fact, self-serving testimony as a substitute for actual contemporaneous evidence and documentation.” It allowed deductions for some flights that reasonably complied with IRS standards, disallowed the rest, and imposed a 20 percent penalty on the unpaid taxes, finding the law firm’s underpayments “negligent and lacking reasonable cause or good faith.”

Attorneys should have known better.