Compensation considerations for mixed use of noncommercial aircraft

This article was originally published on January 30, 2018 and has been updated.

More companies are allowing their top employees and owners to use noncommercial aircraft for business travel (and some personal travel). While permissible, employers must be careful to properly allocate the business vs. personal use of any noncommercial aircraft in order to properly calculate the imputed income to the employee or partner. The noncommercial flight rules also apply limitations on an employer’s tax deductions for such travel. Under current law, employer deductions for aircraft costs attributable to flights for business entertainment and certain personal non-entertainment employee flights can be significantly reduced or eliminated.

The IRS has recently announced additional scrutiny on this topic and says it will be a focal point for IRS exams. Employers should take care in determining the proper tax treatment of noncommercial flights and report the use appropriately.

Imputed income for personal flights

Reg. section 1.61-21(g), and various Revenue Rulings, serve as the primary authoritative guidance for determining the imputed compensation income for employees using employer-provided aircraft (including jets, helicopters, etc.). The amount computed and includable in an employee’s income for personal use of an employer-provided aircraft is based on either the fair market value (FMV) of the transportation provided (using FMV of a similar charter rate) or the Standard Industry Fare Level (SIFL) rate. Each flight’s value is imputed separately (i.e., a round trip flight has, at a minimum, two flights with two separate imputed income amounts) and is determined on a passenger-by-passenger basis. If using the SIFL formula to impute income, the SIFL cents-per-mile rate is multiplied by an aircraft multiple (which are based on the maximum allowable takeoff weight of the aircraft) and a terminal charge is added to determine the total amount. The SIFL cents-per-mile rates and the terminal charge are provided by the Department of Transportation and updated semi-annually. These valuation principles apply to both domestic and international flights.

Complexities arise when a trip on employer-provided aircraft is for mixed use (i.e., when the trip has both personal and business elements). For most companies and partnerships, if the main reason for the travel is a business trip, but the business travelers invite guests, the employees (or partners) traveling to a business meeting have a business purpose, but the guests do not. Thus, in many instances, the value of the guests’ travel is imputed as compensation to the employee that invited the guest.

Whether a flight is “primarily” for business purposes or “primarily” for personal purposes is a facts-and-circumstances determination.

The imputed income rules apply to all flights provided in connection with the performance of services. The rules use the term ‘employee’ to include such service providers, but the term also includes:

• Partners,
• Directors,
• Independent contractors and
• Former employees, partners, directors and independent contractors.

However, the rules are different for a sole proprietor. Sole proprietors are not considered employees and do not impute income for use of the plane (however, see the tax deduction rules below).

Guests of an employee who accompany the employee on noncommercial flights typically result in additional imputed income for the employee. There is a special exception for children under the age of two, whose flights do not result in imputed income to the employee. For example, an employee of a company takes his wife and children with him from their home in Oklahoma City on a two-day business trip to Arizona. After going to Arizona, they traveling to Texas for a longer period of time, such that the trip is deemed to be a personal trip. They then return home to Oklahoma City. The employee has imputed income on the value of personal part of the flights (as if the flight was to Texas and from Texas back to Oklahoma City for himself. The SIFL value for his wife, and his children is also included in the employee’s income. If his children were under the age of two, then imputed income would only be calculated for him and his wife.

A company cannot choose to give up a tax deduction in order to avoid report the SIFL income. The IRS may impute a much higher charter rate inclusion if the employer fails to appropriately impute the inclusion amount to the employee.

Employer deductions for business, entertainment or personal travel

The employer’s cost of operating a noncommercial aircraft, whether for the employee’s business or personal use, may be deductible under Internal Revenue Code (IRC) section 162 as an ordinary business expense. However, there are certain exceptions where the employer’s deduction is disallowed. These losses of deduction are calculated separately for each traveler, so if one passenger is commuting and another passenger is a relative riding along for fun, the expenses for each passenger are based on the purpose of that passenger’s trip.

1. Commuting costs. One of those instances where the employer’s deduction is disallowed is for commuting expenses. Expenses attributable to commuting between the employee’s residence and place of employment are disallowed under IRC section 274(l), except as necessary for ensuring the safety of the employee as determined under an appropriate independent security study. For example, if an employee is a remote executive who lives in New York but travels to the company’s headquarters in Washington D.C., then the executive’s travel between his home and the office is not deductible, even if taken on a private jet, because the expenses incurred are commuting expenses.
2. Entertainment. Expenses incurred for employer-provided flights to entertain clients or employees (e.g., an all-expenses-paid trip to an out-of-state sporting event) are not deductible under the general rule under IRC section 274 that disallows deductions for costs associated with entertainment. Sometimes a guest is traveling for entertainment (such as riding along to see a play in the destination city). In this case the portion of the flight expenses allocated to the guest are entertainment travel and not deductible.

To summarize the general employer deduction treatment:

Takeaways

Determining which category, a specific noncommercial flight falls into usually requires a facts-and-circumstances analysis. Particular attention should be given to mixed-use flights and/or multi-leg flights.

As there is new IRS scrutiny expected for flights on employer-provided aircraft, employers should review their existing travel policies to confirm whether their operations are appropriately considering the intricacies of these rules, reporting the imputed income to affected employees, and monitoring any associated employer deductions.