Point of Law: Federal Excise Tax Changes for Charter
Effective Jan. 19, 2021, new tax regulations clarify how the charter industry should address the Commercial Aviation Federal Excise Tax (FET) with managed aircraft. The regulations will give the charter industry a new sales tool: charter flights for owners in their own aircraft will not be subject to FET.
This means that aircraft owners don’t have to accept responsibility and liability for operational control in order to avoid the 7.5% FET. Most aircraft owners that have their aircraft managed by charter companies choose to operate their aircraft under FAR Part 91 for their own flights in order to avoid the 7.5% FET, and perhaps to avoid the more-stringent safety requirements of Part 135.
A little history: Beginning in the 1990s, the IRS skirmished with fractional ownership programs over how to apply FET. The battle evolved to a question of whether management fees were subject to FET. A fractional-specific fuel tax finally resolved the issue, but by then the long-running war on management fees had spilled over to the charter world. For many years, charter operations provided management services to aircraft owners and chartered the aircraft to the public when not in use by the owner. As the IRS waged war on the fractionals, it targeted charter companies and threatened to assess the 7.5% FET on all management fees.
These battles were finally resolved with the 2017 Tax Cuts & Jobs Act (TCJA). The TCJA gives clear tax protection to aircraft management services, which include:
(1) Assisting an aircraft owner with administrative and support services, such as scheduling, flight planning and weather forecasting.
(2) Obtaining insurance.
(3) Maintenance, storage and fueling of aircraft.
(4) Hiring, training and provision of pilots and crew.
(5) Establishing and complying with safety standards.
(6) Such other services necessary to support flights operated by an aircraft owner.
Note the last item: The TCJA does not refer to Part 91 or 135 in this exemption, but an aircraft owner is not the operator of a Part 135 flight. However, the National Air Transportation Association and the National Business Aviation Association successfully pushed the IRS to interpret “flights operated by an aircraft owner” to include flights conducted by the charter company for the aircraft owner.
Now that a charter company can fly the aircraft owner under Part 135 without FET, who is the owner? The new regulations recognize that an aircraft owner may be a lessee but state that a lease from the management company to a lessee with a term of 31 days or less would be disqualified from the protection of this FET exception. Corporate relationships are often complex, so the owner/lessee language of this provision will be very useful in giving some flexibility in creating aircraft ownership and operating structures.
Tax advisors need to be careful: The IRS does not “disregard” entities for FET purposes in the same way that it disregards entities for federal income tax purposes. The final rules make it clear that each business unit that is required to have a separate Employer Identification Number is treated as a separate person.
The final regulations further clarify that if one related party leases an aircraft to another related party (for more than 31 days), amounts paid by the lessee to an aircraft management services provider for aircraft management services related to the leased aircraft qualify for the aircraft management services exemption.
Who bears the risk on these new regulations? By statute, if FET was in fact due but not paid, “such tax shall be paid by the carrier providing the initial segment of such transportation which begins or ends in the United States.” In other words, the charter industry will need to police these rules, because they will have to pay FET if they were wrong. The IRS noted that these collection issues “require additional study and input from a broader cross-section of stakeholders in the air transportation industry. Accordingly, these issues should be addressed in a separate published guidance project.”
What happens with the fuel tax on owner flights? The proposed rules could have resulted in a fuel tax nightmare for charter companies. The IRS decided to retain the status quo: Because the final rule does not provide fuel excise tax guidance related to the management services FET exemption, companies “should continue to follow current statutory, regulatory and administrative guidance related to the rates of tax for aviation fuel.” This should mean that a Part 135 flight for the owner is still a commercial flight for fuel tax purposes. The industry will surely be seeking verification on this point.
What records should be kept by owners and charter companies? Records should include the agreement between the aircraft owner and the aircraft management services provider, evidence of aircraft ownership, evidence that amounts paid for aircraft management services came from the aircraft owner, the aircraft management services provider’s fee schedule, and documents to support any allocations required under the pro rata allocation rule.
The preamble and new regulations take up more than 70 pages, so please don’t rely on a brief magazine column for tax advice: Consult qualified tax counsel. Overall, these regulations are a substantial win for the industry, but they are complex rules.