The Office of Chief Counsel for the IRS released Memorandum #201210026 on March 9, 2012, stating that when an owner hires an aircraft management company, the owner is seeking taxable transportation services as defined in §4262(a)(1) of the Internal Revenue Code. The transportation is subject to the 7.5 percent federal excise tax on air transportation, even if the aircraft is being operated under Part 91 of the Federal Aviation Regulations (FARs).
The owner is likely to pay the same federal excise tax whether the owner is flying privately under Part 91 of the FARs, or hiring a charter operator under Part 135 of the FARs. This is because prior existing revenue rulings issued by the IRS made the status of the aircraft operator irrelevant in determining the taxability of the operator’s activities.
The key factor in the Chief Counsel’s analysis is how much control the aircraft management company, as the operator of the aircraft, has over the aircraft and its crew, maintenance, safety standards, scheduling, flight planning and weather services.
The IRS examined three distinct but similar owner-manager relationship scenarios under the applicable tax law. In each scenario, Owner retains the Management Company to maintain, fuel, clean and schedule the Owner’s aircraft. Although the Owner can specify crew qualifications, exercise first right of refusal with respect to selection of specific crew, or even exercise its right to abruptly change the crew, the crew members are Management employees who are selected, paid, and trained solely by Management. The Management also maintains all the record keeping of the aircraft for the Owner.
Unlike Scenario 2 and 3, the Owner has exclusive use of the aircraft in Scenario 1, and the aircraft will not be loaned or rented to another passenger. On the other hand, Scenarios 2 and 3 allow for shared aircraft usage with other companies and usage of the aircraft for charter respectively. According to the IRS, all three scenarios share one common trait: the Management Company has possession, command and control of the aircraft. The Owner does not have possession, command and control of the aircraft.
The Owner cannot avoid federal excise taxes if the Owner is relinquishing possession, command and control of the aircraft to an entity that transports the Owner or the Owner’s associates or employees.
The IRS’ legal opinion generates two questions: 1) Can an Owner execute a carefully crafted management agreement that does not give rise to federal excise taxes on air transportation? 2) Is it really worth the effort compared to the alternative?
STAY TUNED FOR SOME ANSWERS ON “WHAT THE IRS WANTS FROM AIRCRAFT MANAGEMENT AGREEMENTS (PART 2)”
Mohammad Faruqui is an attorney in Fort Lauderdale, FL, servicing aviation clients throughout the United States and abroad. Mr. Faruqui is a member of the Florida Bar Aviation Law Committee, the International Air Transportation Safety Bar Association, the Lawyer-Pilot Bar Association and the Aircraft Owners and Pilots Association. He serves as a panel attorney on the AOPA Legal Services Plan. Mr. Faruqui has been licensed to practice law in Florida since 2006, and graduated from Nova-Southeastern University Shepard Broad Law Center in 2005. He is an instrument-rated private pilot with experience in Cessna 172s and Cirrus SR-20s.
Mr. Faruqui can be contacted at Mohammad@Aerolawoffices.com or at (954) 641-2220.
By: Mohammad Ahmed Faruqui, ESQ.
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