Structuring your business jet operation

Figuring out how to own and operate a business jet can be frustrating for owners and their professional advisers. In the U.S., they need to pay attention to four principal objectives:

1. Complying with FAA and DOT requirements.
2. Minimizing applicable federal and state taxes.
3. Maximizing aircraft-related state and federal income tax deductions.
4. Avoiding potential liabilities associated with the jet.

Special objectives, like the desire to lease the aircraft from a financial institution, may provide further complications.

Sadly, it’s close to impossible to create a plan that provides the best possible outcome with regard to all of these objectives. The best solution for achieving one objective inevitably results in a compromise for another.

Let’s look at some of the factors involved.

Operating options. Most business jets in the U.S. fly under the FAA’s non-commercial or commercial (charter) rules (Part 91 or 135, respectively). Part 135 imposes operational restrictions that eliminate some of the flexibility of having your own aircraft, but unlike Part 91, Part 135 lets you charge whatever you want to fly people on your jet. You can operate the aircraft yourself under Part 91 by hiring your own flight crew (an “in-house” flight department); or you can retain a management company for operations under Part 91 and/or Part 135.

Having your own flight department is a little like running your own business and comes with all the usual headaches: employees, hangar and office leases, operating expenses, regulatory compliance. For a first-time buyer, retaining a management company is a pragmatic solution that can get you up and running quickly and offer internal checks and balances that are largely absent if you go it alone. Of course, management companies charge for their services, but they also offer compensatory discounts on fuel, hangar space, maintenance, and insurance. That said, owners who’ve had a rocky experience with a management company often prefer to take charge of things themselves, especially if they havea trusted crew.

A third option is to team up with someone else to own and operate the aircraft. In that case, it’s possible for one owner to operate the aircraft for all of the owners via a regulatory exception created by the FAA. [See “Sharing a Jet,” June/July 2008, at bjtonline.com. —Ed.]

Liability and ownership. Business jets have the capacity to cause a great deal of damage—to the aircraft, to the passengers and crew, and to people and structures on the ground. Two main targets for liabilities are associated with this damage: the owner and the operator. (Other parties—such as the aircraft manufacturer or a maintenance facility that worked on the aircraft—can also be responsible for damage, but statutes or contracts often limit their liability.) The aircraft operator is responsible for safe operation in compliance with FAA regulations, but the owner’s actions (or lack thereof) can place it in jeopardy as well.

A common way to avoid ownership liability is to buy the aircraft in an entity (such as a corporation or limited-liability company) that provides protection by isolating liabilities in the entity. Ideally, this entity would have few if any assets aside from the aircraft. Also ideally, the operational liability would be isolated in the entity as well, but unfortunately the FAA’s position is that an entity that does nothing but operate an aircraft is in the air-transportation business, which requires a commercial operating certificate  for operations under Part 135. [See “The Flight Department Company Trap,” June/July 2013, at bjtonline.com. —Ed.] Obtaining a commercial certificate is expensive and time-consuming, and is thus impractical for most owners.

Many management companies, though, have commercial certificates, so you can avoid operational liability by leasing the aircraft to a management company to operate under the Part 135 commercial rules. This transfers operational liability, but it has significant drawbacks: increased expense, imposition of the 7.5 percent federal transportation excise tax on all amounts paid for the transportation and, as noted earlier, FAA restrictions (such as crew-rest requirements) that limit operating flexibility. Accordingly, many jet owners (who can be either an entity engaged in a business or a person) choose to accept the operational liability by leasing the aircraft from the owning entity and mitigating the exposure through increased insurance. You can buy up to $750 million of liability insurance (or more if you use multiple insurers), which by far exceeds any business jet damage award I’m aware of.

Jet buyers concerned about operational liability should also take a hard look at their overall business structure. In many cases, you can rearrange how you conduct business so that the entity owning the aircraft can operate it as well. A jet buyer who receives compensation as an employee of an operating company, for example, might restructure his services to that company so he is paid as a consultant, with the aircraft owned and operated by his newly formed consulting business.

Don’t make the mistake, however, of thinking you can jettison operational liability by retaining a management company. That company merely assists you in operating your aircraft; you retain operational control and FAA responsibility unless you charter your own aircraft from the management company under Part 135 when you fly. [See “Chartering Your Own Aircraft,” August/September 2011, at bjtonline.com. —Ed.]

While discussing who should own the aircraft, keep in mind that the registered owner with the FAA must satisfy that agency’s U.S. citizenship and registration requirements. Basically, if the proposed owner isn’t a U.S. citizen as defined by FAA regulations or is owned or controlled by persons or entities who aren’t citizens, it may be necessary for the registered owner to be a U.S. trust or to register the aircraft as “based and primarily used” in the U.S. You should examine FAA registration requirements in detail; a partnership, for example, cannot be a registered owner of an aircraft in the U.S. unless all the partners are people, not entities.

Own or lease? An alternative to ownership is leasing. With business jet depreciation rates on the rise, a lease offers the opportunity to pass residual-value risk on to the lessor financial institution—in theory, anyway. Experienced aircraft leasing institutions have been carefully watching those depreciation rates themselves and have been revising their residual assumptions accordingly. From a liability standpoint, leasing might protect the lessor but will ordinarily offer little protection to the lessee. [See “Lessor Liability,” December 2009/January 2010, available at bjtonline.com.—Ed.] And of course, if you don’t own the aircraft, you can’t take depreciation on it for tax purposes.

Minimizing state taxes. Many state taxes affect aviation, but the main culprits are taxes on the sale or use of the aircraft and on its value (property tax). One great virtue of an aircraft from a tax standpoint, its high mobility, can also be a drawback. Thus, you can avoid sales tax by moving the airplane for closing to a state that doesn’t tax aircraft sales, like Massachusetts or Montana, but when you fly to a state that does tax such sales, you may be liable for compensatory use tax there—and potentially in other states as well—depending on your connection (what lawyers call “nexus”) to the state. (The same is true to a lesser extent for property taxes.)

A common structure to minimize use tax is for the entity owning the aircraft to transfer (i.e., lease) it at closing to the person or entity that will operate it. In many states, even though the entities are related, this structure avoids the up-front tax on the purchase price by replacing it with a tax (usually monthly) on the lease payments. [See “Setting a Reasonable Lease Rate,” October/November 2013, at bjtonline.com. —Ed.]

As the rules vary greatly from state to state, with some states welcoming business jets and others not so much, you’d be wise to retain an aviation tax expert to plan for dealing with state taxes well in advance of closing.Minimizing federal taxes. Two main federal taxes apply to business jet operations: excise taxes paid by the aircraft operator when it buys jet fuel—currently about 22 cents per gallon—and the transportation excise tax (often called the “ticket tax”) owed by the person paying for commercial transportation. When awpplicable, the transportation excise tax is 7.5 percent of the total amount paid for taxable transportation, plus a modest segment fee, and payment should result in a refund of fuel taxes paid for the flight.

Because the transportation tax is considerably higher than the fuel tax, the best strategy is to avoid it. Unfortunately, as mentioned earlier, if you want to minimize operational liability by operating under a Part 135 certificate (and thus operating “commercially” for both FAA and IRS purposes), you’ll almost always incur the transportation tax.
Imputed taxable income is also relevant to the extent that passengers are not paying—or not paying enough—for flights. This is ordinarily not an issue when you’re flying on your own aircraft unless a separate taxpaying entity owns it. You can minimize the taxes by reporting the income using the IRS Standard Industry Fare Level (SIFL) formula, which is based on first-class airfare and usually results in imputed income that is far less than the actual financial benefit.

Maximizing tax deductions. Aircraft are expensive to buy and operate, so as business assets, they generate sizable tax deductions. This isn’t the place for a detailed examination of those deductions, which include qualification for accelerated and bonus depreciation, avoidance of passive losses (in the absence of sufficient passive income), and minimizing the impact of the entertainment-use disallowance.

From a structural standpoint, however, a key issue is making sure that the aircraft is actually employed in a trade or business and is thus eligible for tax write-offs.

This is generally not a problem when, say, a Fortune 500 company acquires the aircraft. Increasingly, however, wealthy individuals, not their affiliated companies, make the purchase. This often presents a serious structural challenge for tax purposes, for if the wealthy jet owner uses his aircraft for the business of, say, a company that employs him, the aircraft may be located in the wrong place.

That is, if the company provided the aircraft, it could potentially deduct all the expenses, whereas the employee can write off only unreimbursed employee business expenses, including from his use of the aircraft in the company’s business, to the extent that they exceed 2 percent of adjusted gross income, which is likely a high threshold for a business jet owner. As noted above, if this is your problem, you may want to consider restructuring how you conduct business.

In sum, the two most common business jet ownership and operating structures are: (a) a non-air transportation business owns the aircraft (or leases it from a financial institution) and operates it itself (with or without the assistance of a management company) and (b) an entity with no other assets or business owns the aircraft and leases it to the ultimate operator. 

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Some Planning Tips   
•    Make sure the entity operating the aircraft is in a business other than air transportation.

•    For operational flexibility, avoid operating under Part 135.

•    Buy the aircraft in a state with no tax on aircraft sales.

•    To deduct ownership and operating expenses for tax purposes, make sure the aircraft is employed in a trade or business of the taxpayer.

•    To qualify for accelerated and bonus tax depreciation, make sure that more than 50 percent of the aircraft’s use is in a trade or business. —J.W.    

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Need more help?
National Business Aviation Association members can find information about operating and ownership options (including the NBAA Aircraft Transactions Guide and NBAA Aviation Management Guide) at nbaa.org. 

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Jeff Wieand is a senior vice president at Boston JetSearch and a member of the National Business Aviation Association’s Tax Committee.