Aircraft Owners Forced to Address Potential FET Tax Liability— Originally published in
BusinessAir Magazine, June 2012, Volume 22, No. 6.
Aircraft owners, who don’t wish to handle the day-to-day operations of their airplane, often hire an aircraft management company to manage their asset. Those owners that make this choice now have more potential tax liability than they did a few months ago. On March 9, 2012, the IRS Office of Chief Counsel issued a controversial memorandum. This memo stated that Federal Transportation Excise Tax (“FET”) applies to all fees paid by an aircraft owner to an aircraft management company for management services with respect to owner flights conducted under Federal Aviation Regulations (FAR) Part 91. Many of us in the aviation community vehemently disagree with the assumptions and guidance set forth in the memorandum. However, we have to acknowledge the guidance provided until such time as the IRS agrees to reconsider its position.
Currently, most aircraft management services contracts provide that the management company pays for pilots, insurance and maintenance of the aircraft, at the owner’s direction and expense. This frees the owner from these types of responsibilities. Under the IRS memo, if it is determined that the management company has possession, command and control of the aircraft, then all the amounts paid by the owner to the management company would be subject to the current 7.5% FET rate. Yes, the cost of hiring a management company to manage YOUR aircraft potentially just increased by 7. 5%! The IRS Memo may change the current enforcement and audit practices of the IRS and is completely opposite of the standard management agreement which does not assess or collect any FET. Therefore, all current owners, or future aircraft owners, should do an immediate review of any existing management agreement or future management agreements, in order to determine how the IRS would view who has possession, command and control of the aircraft.
The IRS will look at five specific factors, although it is unclear how these factors will be weighed, in determining who has possession, command and control. The first factor is employment of the pilots. If the Owner employs the pilots directly, this will help demonstrate that the Owner is in command and control of the aircraft. Alternatively, if it is clear that the Owner has exclusive control over the pilots such as the ability to hire and fire at will, then again, based on weighing all of the factors, the Owner will likely be deemed to be in command and control. However, if the aircraft is going to be used by the management company for charter operations under Part 135, the Owner’s employment of the crew may become more problematic from an FAA perspective.
The second factor is aircraft maintenance. If the Owner performs the maintenance, then the aircraft will be considered to be in the Owner’s command and control. This may not be possible if the Owner is going to allow the management company to charter the aircraft from time-to-time on its Part 135 certificate. Under FAR Part 135, the management company must perform the maintenance on the aircraft. However, again, based on the other factors, as long as the management company is acting as the Owner’s agent and is not the ultimate decision maker, the Owner is likely to be still be deemed to be in command and control. It is important to indicate that Owner must make all significant maintenance decisions and must approve any maintenance above a certain threshold amount prior to any work being done on the aircraft.
Third, in order to demonstrate possession, command and control, the Owner should maintain the schedule of the aircraft. The Owner must make all determinations of movement of the aircraft. If the Owner is allowing the management company to use the aircraft from time-to-time for charter flights, the Owner must approve all charter flights and Owner flights should always preempt any charter flights on the schedule.
Fourth, the Owner should select and maintain insurance on the aircraft and pay for the insurance directly if possible. Many aircraft management companies offer fleet policies at a discounted rate. This often provides some savings and the ability to purchase coverage that is not always available to the individual aircraft owner. However, in order to create a fact pattern that clearly demonstrates that the owner is in possession, command and control, it will be necessary to purchase an individual policy and avoid the aircraft management fleet policies.
Finally, the Owner should bear the risk of loss for losses not covered by insurance. If covered by insurance, the owner should be the named insured on liability policies and the loss payee on hull coverage. The management company can be named as an additional insured.
It is important to recognize that the business aviation community has risen up and is making the case to the IRS that the guidance issued by the Chief Counsel’s office is legally wrong and places aircraft owners and management companies in an untenable position when it comes to charter operations. We hope that the IRS will soon recognize the error of its ways and retract the March 9th memorandum.
Unless and until the IRS changes its position, great changes must be taken in drafting the management agreement to avoid the FET and achieve a 7.5% tax savings. Existing management agreements should be reviewed and amended in order to limit the possible FET tax exposure.
Senior Transactional Counsel
Aerlex Law Group
Santa Monica, California