Point of Law: Dealing With An Aircraft Tax Audit

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The U.S. government goes deeper into debt by the day, and most of the states are broke. Most people don’t own aircraft. So, there won’t be a populist revolt if the Internal Revenue Service and the state departments of revenue target corporate aircraft for audit.
Preparation is the key to surviving a tax audit and receiving a “no change” letter acknowledging that your tax returns were proper. Aircraft operators know that the FAA doesn’t believe that an inspection occurred unless the paperwork proves it. The IRS won’t believe that you use your aircraft for business unless the paperwork proves it.  
Do you have documents that show the business purpose of every person in every seat on every leg of every trip? That is what the IRS expects.  And the IRS expects the records to be contemporaneous, not pulled together a year or more later by the harried flight department after the CFO informs them that an audit is underway.
The flight department can provide a great deal of help to the CFO in maintaining current records to prove the business purpose of every person in every seat on every leg of every trip, because the flight department knows the who, when and where of each flight. But the flight department’s knowledge of who flew doesn’t always mean it knows the business purpose of why they flew. The company executives must either give the flight department adequate guidance on the business purpose of each person on each trip, or someone in the C-suite must complete that information in the flight records separately as the flights occur.
And of course, there will always be some non-business flights. If someone is not on business, do your records distinguish between an employee entertainment trip (Vegas bachelor party) and a personal trip (Des Moines funeral)? The employee will need to have fringe benefit income added to his/her W-2 form for either trip, but the company will only lose deductions for the entertainment trip.
How do you handle a tax audit today? Sadly, the answer is, a little less politely than in the past. Most companies have learned to treat government inspectors and auditors with at least a modicum of respect because in the past, a little hospitality usually resulted in a less intensive examination and a better outcome.
A client in the soda business, however, reported this experience: For many years, the company has been visited by a wide variety of government officials performing a wide variety of functions. The company has always had a policy of providing the officials with a clean, well-lighted office to work in, and all of the free soda they could possibly want.
This hospitality backfired when an IRS auditor, who apparently loves root beer, did not want to leave, and kept pursuing new issues and asking for more records to review, so that he could sit and drink root beer in the comfortable private office provided to him.
Be professional and polite but be in control. It is a security conscious world today, so, when you insist that the auditor remain in his/her assigned area and not wander the building, and not talk to other employees, you can and should put those requirements in a security context. If you go to the auditor’s office, those requirements will be imposed on you, so you can present these restrictions in a non-offensive manner.
Along those same lines, insist that all “Information Document Requests” (“IDR” in IRS parlance) be in writing, and that all communication with the company occur through a designated representative.
What are the hot tax audit topics today? The IRS is attacking depreciation deductions, and its favorite weapons are passive activity, hobby loss and entertainment rules. 
The states want “use” tax. Use tax is the evil twin of sales tax. If you buy an aircraft in a tax-free state and bring it home to a state that does impose a sales tax, your state may demand that you pay use tax, even if you have registered the aircraft in Delaware (derisively referred to as the “Delaware Dodge” by state department of revenue auditors). If you have relied on a state tax exemption, make sure that you have documented your compliance with the requirements of the exemption. The states now use FBO tenant lists and FlightAware to establish where an aircraft is actually based.
No audit is fun, but if your company is ready, the auditor will leave and look for a less-prepared victim.
Contact Kent S. Jackson at kjackson@jetlaw.com


Kent Jackson

Kent Jackson is founder and managing partner of Jetlaw. He has contributed this legal column to BCA since 1998 and is also a type-rated airline…