AircraftOwner Online

If you are thinking about buying an aircraft for use in your business in 2011, you need to know that the income tax laws have changed recently and, if you follow a whole bunch of complicated rules, these changes can substantially reduce your cost of owning and operating that aircraft.

First, a warning.  I am not a tax attorney.  I know enough about tax to get myself in trouble in a hurry.  Everyone’s tax situation is different, and the rules and regulations change constantly.  If you are contemplating the purchase of an aircraft and are interested in the actual tax consequences that will apply to your situation, you should contact an accountant who specializes in aircraft taxation.  There are several good ones around the country.  Your regular CPA generally is not going to know about any of the special rules relating to aircraft.  Some CPAs may not even know that there is stuff they don’t know.  If you just use your regular CPA, without verifying that he or she knows about aircraft accounting procedures, you are asking for trouble down the road.  Use a specialist.  It is worth the extra expense.  Also, this article is only about federal income tax.  It does NOT address other types of taxes like sales taxes, use taxes, ad valorem taxes, or other similar taxes and fees.

As in most years, favorable tax treatment in 2011 depends upon whether you are buying a NEW aircraft or a USED aircraft.  The treatment for both types of aircraft has improved dramatically over the past years, but it is VERY different between the two types.

In general, there are three types of expenses that we are concerned with in this article:  “standard” depreciation; “bonus” depreciation; and “Section 179” expenses. 

The most-talked-about of these three items is “bonus” depreciation.  The term “bonus” refers to the fact that the income tax laws currently require that aircraft which can be depreciated usually have to be depreciated over a schedule of either five or seven years (depending on the type of use).  At this rate, the taxpayer would not be able to deduct more than about 20% of the cost of the aircraft in the first year of ownership.  Beginning in 2004, as a way to stimulate the economy and create jobs, however, the government began using the concept of “bonus” depreciation, which allowed people who ordered and placed into use new aircraft to “front load” the depreciation deduction in the year they made the cash outlay.  This had the result of stimulating people to buy new aircraft, which, in turn, kept people employed building them.

For 2011, the way in which bonus depreciation works, is that 100% of the cost of new aircraft, and of new equipment added to used aircraft, on contracts entered into on or after January 1, 2008, and placed into service prior to December 31, 2011, may be taken as a depreciation expense in the year of purchase.  If you have a large liability for taxes in 2011, this is huge.  It has the effect of allowing you to deduct the cost of your aircraft from your taxable income, resulting in less tax due for the year 2011, and might even result in a tax refund.  The current law changes in 2012, the “bonus” is not as much, but is still nothing to sneeze at.  Up to 50% of the cost of the new aircraft can be deducted in 2012 if the aircraft is put into service during that year.  There are even some circumstances where the aircraft owner can receive an extension of up to one year (to December 31, 2013) to put the aircraft into service and still write off 50% of the purchase price as “depreciation” in the year the aircraft is placed into service.  Again, this can result in less income taxes due, or even a tax refund.

“Regular” depreciation is applicable for all aircraft which are legitimately used for business (as distinguished from “hobby”; “personal use”; or “entertainment”).  The rules regarding regular depreciation haven’t really changed much.  Depending upon the type of business use to which the aircraft is put, the most you can depreciate in any one year is dependent upon the Modified Accelerated Cost Recovery system (MACRS) formula, which is only slightly “front loaded”.

Section 179 expensing is different.  It allows you to deduct certain regular operating expenses, within strictly controlled limits.  For 2011, those limits have been made much more liberal than they have been in the past.  For USED aircraft, as well as NEW aircraft, a taxpayer who invests up to $2,500,000.00 in an aircraft may take up to the first $500,000.00 in expenses incurred in 2011 as deductible expenses in 2011.  Again, this can have the result of making the cost of purchasing and operating a used aircraft much less onerous, since much of the purchase cost may be recovered in tax savings in year one.  [Although Section 179 expensing applies to new aircraft as well as used aircraft, in MOST cases, it will be more beneficial for the owner of the new aircraft to use bonus depreciation rather than Section 179 expensing.]

In 2012, this expensing will become much less generous.  At that time, unless there is a change made before the rules become effective, only the first $625,000.00 of investment is eligible to be considered for Section 179 expensing.  Only a maximum of $125,000.00 can actually be expensed in year one.  The benefit of Section 179 expensing is phased out for investments in aircraft in excess of $625,000.00

I was thinking today about my own start in aviation, and how different it would be today versus the 1960s and 70s.  I was the proverbial kid at the airport fence, but, back then, there really weren't too many fences.  Nowadays, it is pretty tough to get up close to aircraft at the local airport.  The freedoms associated with getting in touch with new experiences have been significantly impacted by the security concerns of the nation after 9/11.  This was illustrated just the other day when John and Martha King were placed in handcuffs at gunpoint, and put in the backseats of police cars in California -- all because somebody saw what appeared to be an improper registration number on their rented Cessna 172.

Much of the wonder of flight has been deleted or hidden.  Perhaps the two biggest stimulii in recent years to renew interest in aviation, the Space Shuttle program and the Red Bull Air Races, appear to be coming to an end.  The last Shuttle is now slated to launch in February, and the 2011 Red Bull Air Races are not at all certain to take place after the truncation of the end of the 2010 series.  Flying commercial has become an ordeal,from the bait and switch on-line booking programs, to the TSA's violation of the privacy and dignity of travelers, to the ever-shrinking seat pitch, to the hub and spoke system -- all of which have combined to make the total time travelling from door to door equal to or longer than the time it would take to DRIVE from your house to your ultimate destination, on all but the longest flights.  Airplanes are modern-day time machines, capable of leaping great distances in a single bound, at speeds considerably faster than a locomotive; of taking you from sun-soaked beaches to snow capped mountains in a matter of an hour or less in many cases.  But we have, in the name of inexpensive tickets, corporate profits, and national security, put so many obstacles in the way, that the best capabilities of modern aviation have been lost.

About the only way that one can truly enjoy the full majesty of aviation these days is by private flying, but it has become inordinately expensive to fly privately in the modern era.  Even the LSAs cost well over $100,000.00.  Getting a pilot's license costs in excess of $7,000.00 almost everywhere -- in some cases, substantially in excess. Operating a business jet is a luxury only the truly rich can afford.

Most pilots I know have a belief that they have earned the "right" to fly by having been determined to be qualified to hold a pilot's certificate.  But it is NOT a "right".  It is a privilege.  And, unless we can find a different way to balance public safety against the needs of the flying community to get the most from their aircraft, that privilege will become more and more rare.  Unless we regain some of the attributes that make young kids want to be a pilot someday, we will very-quickly lose the pool of political influence (small though it may be even right now) necessary to preserve our hobby, avocation, vocation and industry.  I don't know what the answers are; but I do know that unless we acknowledge the problems, find answers, and continue to push for the political protection of the benefits of aviation, there may no longer even be local airports, with small, private planes, for kids to stare at, except in the history books.

    If you own, or are thinking of owning, an aircraft manufactured in another country and imported into the United States, you should be aware of the ruling of the NTSB in a recent case. Here are the facts as a prospective purchaser would see them:

    The Aerospatiale Alouette II helicopter has been manufactured in France since the 1950’s and has been used as a military aircraft. At least 70 Alouette II helicopters have been imported into the United States and have been given Normal Category Standard Airworthiness Certificates by the FAA. The particular helicopter involved in this case was manufactured in September of 1959 and went directly to the German military. The Buyers purchased a helicopter with a US Normal Category Standard Airworthiness Certificate, and with an existing N registration, as one of three Alouette II helicopters they were considering for purchase, all of which had US registration numbers and Normal Category Standard Airworthiness Certificates. The FAA had previously issued a Type Certificate – No. 7H1 – for this model helicopter. An FAA Designated Airworthiness Representative (DAR) had issued the Standard Airworthiness Certificate for the helicopter. The helicopter in question had been the subject of an “attestation” written on the letterhead of “Aviation Civile” which stated “Although we have not inspected ourselves [helicopter SE 3130 – Alouetter II S/N 1312], we can certify . . . on the basis of the information listed on the individual record inspection log book at Erocopter’s, that . . . the basis design of the above mentioned helicopter . . . was at the time of manufacture . . . compliant with DGAC Type Certificate No. 1 and with the FAA Type Certificate No. 7H1”. The FAA expressly agreed that the helicopter was safe for operation.

    The Buyers bought the helicopter for $165,000.00 and put it to work in a commercial operation.

    The FAA had, since 2004, had concerns with military surplus helicopters. The FAA, unbeknownst to the public, had formed the “Charter Quest Special Emphasis Investigations Team” based out of the Alliance Airport in the Southwest Region, for the specific purpose of looking through the documentation of each of the foreign military surplus helicopters operating on Normal Category Standard Airworthiness Certificates to make sure that they each had proper documentation that the French Government had issued an appropriate letter after an inspection of each particular helicopter. If they did not find such a document, the FAA would then issue an Order of Emergency Revocation of the Airworthiness Certificate of the helicopter. That is what happened here. (In prior columns, I have written about my perception that the FAA is abusing their power to determine that an emergency situation exists. This is just one more example of that. In this case, everyone agreed that the aircraft was perfectly safe to operate, and that the only alleged problem was a problem of documentation. In fact, at the time of the hearing, the FAA had issued an “Experimental Airworthiness Certificate” to the same aircraft. So, what was the “emergency”?)

    Now, dear reader, you might be asking yourself, “well, didn’t these buyers have a letter from the French Government?” And the answer would be, “sort of”.

    It turns out that the actual arm of the French Government which has the power to issue Type Certificate Data Sheets is called the “Direction Générale de l’Aviation Civile (DGAC).” Our buyers had an attestation from the “Groupement Pour la Securite Aviation Civile (GSAC)”. This entity shares the same logo as the DGAG.

    The Trial Judge, in his Order, stated: “I think it was brought up and brought to our attention that the fifteenth revision to this type certificate data sheet identifies these people as being the same as the DGAC of France or the civil aviation authority over there.” The NTSB itself, only noted in its opinion: “Groupement Pour la Securite Avaition Civile appears to be a French organization separate from the DGAC, but involved in promoting aviation safety by conducting inspections.”

    (I find it alarming that neither the FAA counsel, nor the attorney for the buyers – or for that matter the NTSB, appear to have even performed a Google search of this group. If they had, they would have known that, according to the GSAC: “The Direction G‚n‚rale de l’Aviation Civile (DGAC) has delegated to the Groupement pour la S‚curit‚ de l’Aviation Civile (GSAC) the responsibility to carry out aeronautical technical inspection tasks in its name. The GSAC is a public-private economic interest group, grouping together DGAC, Bureau Veritas and SOFREAVIA. It carries out inspections and checkings of aircrafts, aircraft parts and gears, in France and other countries. It audits institutions in the design, production and maintenance fields, including the engineer training institutions. The inspections, checkings and audits serve the purpose of issuing and renewing airworthiness certificates and permit to fly, aircraft operator certificates, design, production and maintenance approvals, ground mechanic training organisation approvals, aircraft station licenses (LSA) and ground mechanic licenses. In other words, the GSAC is, in fact, the entity that has been delegated the authority to inspect for compliance with the requirements of airworthiness certificates on behalf of the DGAC. This is why they share a common logo.”)

    Both the Judge and the NTSB seemed to get this distinction somewhat, although the FAA contended to the end that the GSAC is not the French government, therefore, the buyers’ certificate came from the wrong people.

    What tripped up the buyers ultimately, however, was the first sentence fragment of the attestation that they did provide: “Although we have not inspected this helicopter...” The actual Type Certificate Data Sheet No. 7H1, issued by the FAA for the Aerospatiale Alouette II helicopter, specifically provides, however: “A U.S. Airworthiness Certificate may be issued on the basis of a Certificate of Airworthiness for Export signed by a representative of the Secretariat General a l’Avaition Civile containing the following statement: ‘The helicopter covered by this certificate has been examined and found to comply with U.S. Civil Air Regulation Part 6, dated January 15, 1951, including Amendments 6-1 through 6-8, and with the Special Requirements notified to the Government of France by the Government of the United States of America and conforms to T.C. 7H1.’ “This type of certification by a foreign Government is known as a “Certificate de Navigability.”

    There was nothing that the buyers could produce to show that any arm of the French government, whether that be the DGAC itself, or the GSAC acting as the delegated representative of the DGAC, had actually inspected the aircraft at the time of export to assure the United States Government that no modifications had been made which might have caused the aircraft not to have complied with the French Type Certificate No. 1 or the US Type Certificate No. 7H1.

    “But”, you might ask, “didn’t a US Designated Airworthiness Representative inspect the helicopter to determine that it was airworthy and safe for operation before granting the helicopter a Normal Category Standard Airworthiness Certificate?” Yes, one sure did. In fact, the way it worked is that an A&P went over this helicopter and its logbooks with a fine-tooth comb and decided that it was airworthy. The A&P then certified this finding to the DAR, who made his own inspection, agreed, and issued the Standard Airworthiness Certificate. The statement of a DAR is considered the act of the FAA Administrator himself, since the DAR is the Administrator’s designated representative.

    However, and this cannot be stressed enough, the concept of “airworthiness” – as interpreted by the FAA and the NTSB is not simply a certification that the aircraft is safe for operation. The test for “airworthiness” is a two-pronged test, the first prong of which is that “the aircraft is in compliance with its Type Certificate Data Sheet.”

    What really happened here, and it is not the first time this has happened, nor is it likely to be the last, is that the FAA changed its mind. Even though there were some 70 buyers out there who had acted in good faith, and had relied on the A&P’s who inspected the logbooks and the helicopters, the DAR’s who inspected the logbooks and the helicopters, the FAA Certification Branch which issued the Type Certificate for the helicopter back in 1951 (when it was the CAA), and who registered the aircraft in N registry, the FAA decided that it no longer liked the fact that people were using these older foreign military surplus helicopters for commercial operations. So they set up a special unit to go out and find ways to declare these helicopters “un-airworthy” and to revoke their certificates on an emergency basis.

    The Administrative Law Judge was extremely apologetic to the buyers throughout his opinion. In speaking about cases like this where the Administrator changes his mind, he stated: “Once the Administrator takes that action, it’s extremely unfair to the folks that it’s directed to, but at the same time, you can’t help but step back and say, well, what other choice did the Administrator have under the circumstances?” When the FAA tried to blame the buyers, saying that the buyers had not done their due diligence, the Judge shot back: “He (the buyer) went out there with three of these helicopters. They looked at the airworthiness certificate. They looked beyond the airworthiness certificate. They looked at the logbooks and records, and they believed that because it did have an airworthiness certificate and these other records from the Administrator that it was a good buy, and they paid $165,000 for that aircraft. And now, with this emergency order of suspension, even though it has an experimental certificate, it cannot be used for any of the purposes they talked about and that they had used it for before, because you can’t use an experimental aircraft for commercial purposes..”

    Also in responding to the Administrator’s argument that the buyers didn’t perform their due diligence, the Judge said: “one of [these arguments] was that these people didn’t do their due diligence, but they did. If there’s anybody that didn’t do their due diligence, it was the representatives of the Administrator in not following up on this.”

    Nevertheless, the Administrative Law Judge felt that he had no choice and suspended the Standard Airworthiness Certificate for the helicopter. The buyers appealed to the NTSB. The Board was also somewhat sympathetic to the buyers, saying: “We note that DAR Cernuda’s and Mr. Marrs’s mistakes are troubling, and we sympathize with respondents’ position that they relied upon the FAA to issue a standard certificate of airworthiness for N225RW only if the aircraft was airworthy. However, we have previously held that such errors do not prohibit the FAA from taking action against a certificate.”

    There are important lessons to be learned from this case. While most modern aircraft being manufactured in foreign countries apply for, and receive, US Type Certificates at the time of their manufacture, and are approved for direct sale by dealers in this country – as opposed to having to be imported from their country of manufacture – many older aircraft lack this documentation. The rules for each of these aircraft are different, and must be understood at a great level of detail by the people who wish to buy and operate them in the United States. Buyers of older foreign aircraft should be aware of this.

            In addition, it is important for aviators to understand that each Flight Standards District Office and Regional Center has the ability to assemble Special Emphasis Investigation Teams. This is being done more and more in recent years. These teams generally operate more-or-less in secret, with little or no public notice, with the goal of correcting a perceived problem that is not isolated. Such a team led to the shutdown of TAG, allegedly for issues concerning control by a foreign company; and other similar matters. They are often heavy-handed, developing new ways of looking at regulations to support their conclusions, gathering evidence under the cover of inspections of other, seemingly-insignificant matters, and then pouncing all at once, bringing the work of the subject of the investigation to an immediate standstill with no warning, and using expedited procedures to force the subject to gather his evidence and present his defense in less than thirty days all the while trying to pay attorneys without any present cash flow. Is it unfair? You bet it is. In a true “emergency” as most of us understand it – when there is imminent danger of death, personal injury, or property damage – it makes sense for the FAA to use these powers. But using them to enforce a policy change with regard to paperwork violations having nothing to do with safety, is simply wrong at every level.

Many buyers seem to believe that they can avoid sales tax by forming a corporation, usually in Delaware, and having the corporation take title to the aircraft. The bad news is that this does not protect you from sales tax. The even worse news is that it may also cause your aircraft registration to be invalid, your aircraft being required to be operated under Part 135 of the Federal Aviation Regulations, and Federal Excise Tax being due on trips you make in the aircraft.

    As the states have been getting less and less income, they have tended to focus on unpaid sales taxes as a source for getting quick infusions of cash. The best place for the states to look is at “big-ticket” items, like aircraft and yachts. With advances in technology, it is easier than ever before for the states to find out when an aircraft has changed hands. In fact, the FAA actually sends each state a listing of the aircraft registered each month with addresses in that state.

    Since the Revenue Departments of the states are aware that aircraft may be registered in a state for the sole purpose of avoiding sales tax in the state where the aircraft is actually based, each state has composed teams of inspectors whose job is to go from airport to airport, and from fly-in community to fly-in community, logging aircraft that are on the ramp and in hangars. Some states, like Florida, if they see the same aircraft at the same airport on more than one visit simply presume that the aircraft is based at that airport and send a tax bill for “use tax’ (which is often the same amount as the sales tax would have been) and put the burden on the registered owner to prove that the aircraft is actually based out of state.

    The states also place substantial penalties on the failure to have paid taxes on a timely basis, so, in addition to the time, aggravation and expense of satisfying the state’s official inquiries, you are at risk for large penalties and interest payments if the state determines that you deliberately failed to pay the tax that was due.

    Many aircraft owners also feel that they can be protected from taxes by the corporate form of owner-ship. However, the owner of the corporation must be able to show that the corporation has some actual corporate purpose to benefit from the corporate veil. More importantly, the FAA has a different way of looking at corporate ownership of an aircraft. The FAA says that unless the corporation that owns the aircraft has a real business purpose other than just owning and operating the aircraft, such that the use of the aircraft is merely “incidental” to the business of the company, the company is actually engaging in the “commercial” use of the aircraft since it is serving no other purpose other than providing transportation by air to members of the corporation. Therefore, the FAA argues, the aircraft must be operated pursuant to the requirements of Part 135 of the Federal Aviation Regulations, and each failure on your part to comply with the requirements of Part 135, can subject you to a “civil penalty” in the amount of up to $11,000.00 per violation.

    The FAA also has a strict “citizenship test” which it uses for corporations. Unless the President of the corporation, AND at least two-thirds of the other officers and directors, AND at least 75% of the shareholders of the corporation are United States citizens, the corporation will NOT be deemed to be a “citizen” for registration purposes, and the FAA, DOT and Customs will all deem the N registration of your aircraft to be illegal, which can result in seizure and forfeiture of your aircraft, large fines, and even the possibility of jail time.

    There are ways to minimize the exposure to sales taxes, but they require complex planning prior to the closing of the sale. For most general aviation transactions, the most cost-effective thing to do is to find out what the taxes are and to pay them when they are due, rather than to try to avoid or minimize them. If a substantial amount of savings might be due, then consulting a good aviation attorney or accountant might be a very wise investment. But you should do this when you START the process of buying an aircraft, NOT when you are a day or two away from closing, as the process of minimizing these taxes is complicated and takes time.