Tax Blog/Blawg

The two happiest days in a boat owner’s life are the day they purchase the boat and the day they sell it, or so the old adage goes.  The same saw may apply to the purchase of private jets, as they are massively expensive to maintain and operate, particularly if the owner hires others to deal with the many hassles of ownership.  Nevertheless, due to the pandemic, there has been a spike in private air travel.  Many wealthy individuals opt for chartering jets or joining private jet membership clubs like Net Jets, Blue Sky Jets, and Wheels Up.  But for some, there’s nothing like owning your own plane. 

There are several tax benefits to aircraft ownership, including a 100% bonus deprecation if used for business purposes, but there are also layers of Federal, state and local tax burdens.  These include Federal air transportation excise taxes under Internal Revenue Code sections 4261 and 4271, which impose excise taxes on certain amounts paid for transportation of persons or property by air. 

The Tax Cuts and Jobs Act (“TCJA”), added an exception to the Federal air transportation excise tax in the new Section 4261(e)(5).  This section provides that “[n]o tax shall be imposed by [section 4261] or section 4271 on any amounts paid by an aircraft owner for aircraft management services related to – (i) maintenance and support of the aircraft owner's aircraft, or (ii) flights on the aircraft owner's aircraft.”  On January 11, 2021, Treasury pre-released regulations that interpret the TCJA’s new Section 4261(e)(5).

Section 4261(e)(5)(B) defines the term “aircraft management services” to include: (a) assisting an aircraft owner with administrative and support services, such as scheduling, flight planning, and weather forecasting; (b) obtaining insurance; (c) maintenance, storage, and fueling of aircraft; (d) hiring, training, and provision of pilots and crew; (e) establishing and complying with safety standards; and (f) such other services as are necessary to support flights operated by an aircraft owner.  The newly minted regulations further clarify that the definition of “aircraft management services” is “[a]ny service (including, but not limited to, purchasing fuel, purchasing aircraft parts, and arranging for the fueling of an aircraft owner’s aircraft) provided directly or indirectly to an aircraft owner in order to provide air transportation to the aircraft owner on the aircraft owner’s aircraft at a level and quality of service required under the agreement between the aircraft owner and the aircraft management services provider.”

Section 4261(e)(5)(C)(i) provides that the term “aircraft owner” generally includes a person who holds legal title to the aircraft, or person who holds substantial incidents of ownership in the aircraft for a period of more than 31 day, which may include those who lease an aircraft for more than 31 days.  The new regulations make important clarifications regarding the definition of “aircraft owner” including in the context of leases, trusts and fractional ownership programs. 

A common ownership structure for private jets is a trust used for the limited purpose of registering an aircraft in the U.S. with the Federal Aviation Administration (“FAA”). Most owner trusts are established using one of a small number of U.S.-based aviation trust companies unrelated to the trust beneficiary as trustee. The trustee holds legal title to the aircraft and satisfies the U.S. citizenship requirement for purposes of registering the aircraft with the FAA, thereby permitting registration in the U.S. of an aircraft regardless of whether it would otherwise be eligible for such registration.  These owner trusts often work in conjunction with an operating agreement that contain lease-like language and provide that the beneficiary holds the exclusive right to lease and operate the aircraft.  Such operating agreements usually require that the beneficiary hire the crew and maintain the aircraft in accordance with FAA guidance.  The beneficiary of the owner trust may hold attributes of aircraft ownership such as the right to any income generated by – and obligation to pay all expenses associated with – the aircraft, the upside benefit or downside risk as to the aircraft's value, bearing the risk of loss, being considered the owner of the aircraft for Federal income tax purposes, and discretion as to when to sell the aircraft. 

The new regulations confirm that such an operating agreement between the trustee and the beneficiary of an owner trust is treated as a lease for purposes of the Federal excise tax, regardless of whether the document expressly refers to the arrangement as a lease. Therefore, under the terms of the operating agreement, the beneficiary of an owner trust is the lessee of the aircraft held in trust.  For practitioners, there are layers of tax issues to consider in how these arrangements are characterized for Federal tax purposes as well as state sales tax purposes, and the regulations assist in resolving at least one of those layers.   

It is important to note that these regulations have not yet been published in the Federal Register and are likely subject to review by the incoming Administration, which may give these regulations a second look along with other last-minute executive actions.