- Aircraft Purchase, Ownership, and Operation: Issues to Consider
- July 24, 2013 | Author: Katie A. Ahern
- Law Firm: Hinckley, Allen & Snyder LLP - Providence Office
Utilizing an aircraft often adds value to your business and time to your life. However, a prospective aircraft purchase should also prompt consideration of numerous business issues, legal and tax implications, and regulatory rules. Given these overlapping concerns, an effective planning solution with regard to one issue may trigger ramifications in another area. Intersections of government regulations, federal and state tax rules, and business concerns highlight the importance of careful planning and education regarding the unique issues surrounding aircraft ownership and operation. Whether you currently own an aircraft or are considering a purchase, the below may serve as a helpful “checklist” to guide you through key issues.
The type of person or entity that owns the aircraft (e.g. individual, corporation, limited liability company) affects the liability and tax results for aircraft owners, as well as the ability to operate the aircraft legally and for the purposes intended.
PART 91 VERSUS PART 135 OPERATIONS
Business and personal use aircraft are typically operated under either Part 91 (non-commercial, private carriage) or Part 135 (commercial, carriage for hire such as charter flights). Part 135 operators and flights are subject to additional rules and restrictions, and the operator must possess a government issued air carrier certificate. An understanding of the FAA rules will help prevent a Part 91 operator from inadvertently conducting illegal Part 135 charter operations. For example, use of the aircraft by others, even related companies or individuals, is very limited under Part 91. However, certain exceptions are available. Illegal operations may result in, among other things, FAA penalties and denial of insurance coverage.
FLIGHT DEPARTMENT COMPANY ISSUES
In order to operate an aircraft under Part 91, the operation of the aircraft must be incidental to and within the scope of another business purpose of the operator. In an attempt to limit potential liability, many aircraft owners will set up a flight department company (e.g., an LLC that owns the plane but has no other business). By doing so, the owner may inadvertently violate FAA rules and therefore increase exposure by violating insurance policy provisions. Aircraft ownership and operation can typically be structured to avoid this FAA issue.
SHARING THE AIRCRAFT
Affiliated and non-affiliated persons and entities may enter into various types of agreements to share ownership and/or use of an aircraft, such as leases, time sharing agreements, joint ownership, charter flights, etc. However, these arrangements should appropriately address issues such as state and federal taxes, risk allocation, compliance with FAA and international registration, operational control, payment terms, and use priority. In addition, proper FAA reporting of these arrangements is necessary to avoid U.S. registration violations.
The issues discussed in this article should be addressed prior to the purchase of the aircraft. They are often difficult, if not impossible, to cure post-closing and may delay a closing if raised too late in the purchase process. Additionally, failure to consider these issues at the outset may derail intended aircraft use and trigger adverse financial and tax implications.
Before entering into a purchase agreement, a potential buyer should assemble an appropriate team, which may include accountant, general counsel, aviation counsel, broker, aviation consultant, management company, lender, risk management advisor, and flight department. Both letter of intent and purchase agreement should be carefully drafted and reviewed and should address certain key issues to avoid misunderstandings, re-negotiations, and delays down the road.
Loan and financing lease documents may limit the use of an aircraft or require notice of certain events but can typically be drafted to meet each party’s goals. Owners and operators should carefully review financing documents to be sure that their goals are met and to avoid an accidental default.
The scope of pre-purchase inspections to be conducted should be specified and documented during the initial stages of purchase negotiations. The scope of pre-purchase inspection and the responsibilities of Buyer and Seller with respect to remediation of identified “Discrepancies” are often the most highly negotiated provisions of the Purchase and Sale Agreement. In addition, it is advisable to have an aviation advisor on-site during such inspections.
Proper searches should be conducted in applicable geographic and regulatory jurisdictions, including the FAA Registry and International Registry, to avoid title problems.
UNITED STATES AIRCRAFT REGISTRATION
An aircraft must be properly registered with the Federal Aviation Administration (FAA), with evidence of registration on board. Potential consequences of improper registration include grounding of the aircraft, violation of financing terms, loss of insurance coverage, and loss of preferred registration number or “N number.” Note that new FAA registration and periodic re-registration rules are now in effect.
In addition to the FAA registry, an international registry is available with its own specific registration rules and restrictions. “IR” registration is generally advisable to protect title to an aircraft, even where it is also registered with the FAA.
IMPORTING/EXPORTING AN AIRCRAFT
Those purchasing an aircraft from outside the U.S., or selling an aircraft to someone outside the U.S., should consider issues such as allocating risk, conducting proper lien searches, obtaining a certificate of airworthiness, de-registration/registration, sales and use/VAT taxes, and export control requirements.
International regulations, insurance requirements and tax issues must be considered and addressed when operating outside the United States.
Non-U.S. citizens, as well as entities owned by non-U.S. citizens, are limited in their ability to own and register aircraft in the U.S. Fortunately, such persons may use alternate ownership structures to accomplish their goals such as owner trusts, voting trusts, or “based and primarily used” registration.
SALES AND USE TAXES
Many states tax not only the sale of an aircraft but also the use of an aircraft within its borders. Numerous, complex sales and use tax rules and exceptions exist in each state, vary greatly from state to state, and without careful planning, may result in a substantial unexpected cost. While it is easy to structure the location where an aircraft “sale” will occur, owners need to address the “use tax rules” in any jurisdiction where their aircraft is based or operated.
PERSONAL USE OF THE AIRCRAFT
Part 91 operators are generally not allowed to provide transportation for compensation. However, with planning certain compensation arrangements may be allowed. IRS rules, on the other hand, require that employees making personal use of an aircraft either reimburse the company or income will be imputed to the employee. Careful planning is needed to simultaneously comply with both the FAA and the IRS rules regarding personal use. See also FAA Relaxes Personal Travel Rules.
USING THE AIRCRAFT FOR ENTERTAINMENT PURPOSES
If directors, officers, or owners of a company use the aircraft for entertainment use, certain of the company’s tax deductions related to the aircraft may be disallowed by the IRS.
Use of company aircraft often triggers SEC reporting obligations for public companies. Terms of certain agreements with respect to the aircraft may be subject to disclosure.
AIRCRAFT MANAGEMENT SERVICES
If another related or unrelated entity will manage the aircraft, the parties should prepare an agreement addressing such issues as operational control of the aircraft, insurance provisions, risk allocation, tax issues, maintenance, etc. Such an agreement provides predictability and avoids flight interruption. In addition, the IRS aggressively imposes Federal Excise Tax (FET) on aircraft managed by third parties. Owners should have their management agreements reviewed to mitigate the possibility of the imposition of FET.
For aircraft used in business, tax deductions may include fuel, flight crew salaries, repairs, insurance, and interest expense. Be careful to distinguish currently deductible items from items that must be capitalized and deducted over time.
An aircraft used for business purposes may be depreciated, creating deductions over time. Aircraft owners are sometimes eligible for additional depreciation and/or accelerated depreciation. Bear in mind that certain loss limitations, as discussed below, may limit deductions.
PASSIVE ACTIVITY LIMITATION
This rule limits the tax deduction of losses from passive activities. Since deductions for the depreciation of an aircraft are often a substantial contributor to overall losses, this limitation typically means that an aircraft owner is not able to fully utilize the depreciation deductions. Passive activity issues often arise where the taxpayer does not materially participate in the activity or where the aircraft is chartered or leased to other persons. This limitation may affect individuals, estates, trusts, partners, and LLC members. See also Passive Activity Loss.
Similarly, deductions may be limited or disallowed where a taxpayer does not have a sufficient amount at risk with respect to the aircraft. Aircraft purchasers should consider the effects of the at-risk limitation when evaluating financing options, including recourse, non-recourse, and guarantee provisions.
HOBBY LOSS LIMITATION
The “hobby loss” rules limit deductions arising from activities that are not conducted for profit. Certain presumptions and factors determine when an activity is conducted for profit and when the deduction limitations apply.
FEDERAL EXCISE TAX
Commercial aircraft operations are generally subject to federal excise taxes. Note that the Internal Revenue Service view on what constitutes commercial operations differs from the FAA view. The IRS is currently asserting federal excise tax liability on many Part 91 managed aircraft. Careful review of management contracts is advisable.
The sale of an aircraft used in business is likely to result in taxable income. However, with careful planning, an aircraft owner may be able to defer taxation by “exchanging” one aircraft for another.
EMPLOYEES AND INDEPENDENT CONTRACTORS
Pilots, flight crews, and others should be properly classified as independent contractors or employees for both federal and state law purposes to ensure compliance with state and federal withholding rules, reporting rules, and labor laws.
Detailed aircraft activity is typically available to the public, but aircraft owners may take certain steps to keep transportation information private.
Aircraft must be operated in accordance with certain regulatory rules, such as noise and airspace restrictions.
Aircraft owners and operators should consider several important issues, such as appropriate insurance policy coverage and limits, when to notify an insurance carrier of certain events, what actions and inactions may cause a lapse in insurance coverage, who should be named as a loss payees and “additional insureds,” whether hangar insurance is necessary, whether other types of add-on coverage are necessary, etc. Special attention to insurance is necessary where a management or charter company provides insurance coverage or when an aircraft is financed.