Should the 7.5% Federal Excise Tax (FET), which applies to airline tickets and charter, also apply to fees paid to fractional aircraft and business aircraft management companies? That decades-old question was only partially answered by the U.S. District Court in its recent rulings on NetJets and government motions.
This January, the Ohio U.S. District Court ruled on motions for summary judgment filed by both fractional operator NetJets and the government regarding FET on those management fees, and whether NetJets and its subsidiary Executive Jet Management (EJM) provide taxable commercial transportation.
The Court held that NetJets does provide taxable transportation. However, a ruling in 1992 that applies only to NetJets (not the entire industry), precludes the IRS from taxing NetJets on management fees and fuel surcharges.
The Court also denied separate motions by EJM and the IRS as to whether EJM was providing taxable transportation to customers who allow EJM to charter their aircraft to third parties, which leaves this issue open to further litigation or settlement. No decision was made as to EJM clients who operate only for their own use (Part 91).
Thus, there are many unanswered questions with the ongoing IRS audits of management companies:
- Enrolling your aircraft on a charter certificate allows you to charter your own airplane and thereby allocate trip costs to a specific project at retail charter rates, as well as generate revenue from third party charters when you’re not flying. Does operating as such make taxable the fees charged to you by your charter management company?
- What does this ruling mean for fractional companies? Because it applies only to NetJets, other fractional programs may not claim the same protection. In 2004, the IRS ruled on a different fractional program, saying that monthly management fees were indeed part of taxable transportation, and FET applied. The Court ruled that NetJets was not bound by another fractional program’s ruling.
What does this mean for management companies? In this case, the IRS only assessed FET on arrangements in which EJM both provided traditional management services and used the customer’s aircraft in the EJM Part 135 charter business. No action was filed by the government on Part 91-only managed aircraft.
The Court did say that the arrangement must undergo a factual analysis to determine whether the owner or the charter company has “possession, command, and control” (PCC) of the aircraft.
NetJets argued that EJM has PCC only during a charter flight, while the owner has PCC when the aircraft was flying for the owner. The government argued under a 1974 ruling that the charter operator (in this case, EJM) must have PCC for all activity and that the owner’s payments must be for taxable transportation. The Court dismissed both arguments and said that each arrangement must be determined by factual analysis of many factors, including:
- Ownership of the aircraft
- Who provides the services that allow the aircraft to be operational
- Who provides the crew, and
- The nature of the transportation service provided by the charter company.
It’s important to note that providing the crew and employing the crew were not considered to be identical, but that employment of the crew appeared to be paramount. Furthermore, PCC is governed by tax law analysis, and cannot be contracted away.
Since no resolution was provided on aircraft management arrangements, owners will continue to be subject to a “facts and circumstances” analysis in IRS audits. However, audits currently are being suspended at the appeals level, as the IRS and Treasury Department work on developing a formal regulation. Industry trade associations, such as the National Business Aviation Association and National Air Transportation Association, are actively engaged with the government on your behalf, offering their practical input to the proposed rules. BAA
Glenn Hediger, President of Aviation Financial Consulting, provides tax, accounting, and compliance consulting on personal and entertainment use income and deductions, SEC reporting, GAAP tax accounting, and acquisition/disposition planning.
