IRS Ramps Up Audits on Corporate Aircraft Use for High-Net-Worth Individuals and Affiliated Entities

The Internal Revenue Code can offer significant tax benefits for the use of a company-provided aircraft. However, this benefit can often come with significant time and resources spent on tax audits if the aircraft ownership is not properly structured and the use is not compliant from a tax perspective, particularly when an aircraft is used for both business and personal purposes during the year. Corporate aircraft travel may have a tax impact on both the company and the passenger. Namely, the company may receive a deduction on its tax return depending on the circumstances of the flight. Additionally, a qualifying corporate aircraft is eligible for bonus depreciation. For example, for tax year 2024, a qualifying corporate aircraft is eligible for 60 percent bonus depreciation, meaning that a taxpayer is allowed an immediate deduction of 60 percent for the cost of a qualifying aircraft acquired and placed in service by the qualifying date. For prior tax years 2018 through 2022, the applicable bonus depreciation percentage was 100 for a qualifying corporate aircraft, meaning that a taxpayer was allowed an immediate deduction of 100 percent. However, to qualify, companies are subject to intricate federal tax rules and regulations. For example, the rule for bonus depreciation requires a qualifying corporate aircraft to have travel categorized as “qualified business use” generally exceeding 50 percent of all travel for the aircraft each taxable year. But within the 50 percent calculation, the company must also satisfy a separate 25 percent test which looks at use of the aircraft by owners, related persons and whether the use of the aircraft was related to compensation. If a taxpayer does not satisfy the 50 percent business usage criteria during the useful life of the aircraft, there will be recapture of the bonus depreciation previously taken, and the taxpayer will generally be limited to using the straight-line method of depreciation.

On the passenger side, a passenger (often an owner, officer, director or employee of the company) may be required to impute income on his or her tax return for federal income tax purposes for the passenger’s use of a corporate aircraft. Guests who are not company officers or employees also need to document their purpose for using corporate aircraft, as there may be imputed income consequences and other considerations for their flights. Additionally, under the category of “personal” flights, there are different subcategories—such as entertainment, personal non-entertainment and commuting—which can result in different tax consequences for both the passenger and the company.

Corporate aircraft use is also subject to myriad record-keeping requirements, which often present a challenge to taxpayers. To take advantage of the tax deductions, a company needs to keep complete records of each flight, with adequate records or sufficient evidence substantiating the purpose and details of the flight. However, what constitutes “adequate records” or “sufficient evidence” can be a source of contention between the IRS and a taxpayer.

Another contentious issue is what constitutes a “business” flight for purposes of the federal tax deduction whose business the flight must relate to. The Treasury Regulations provide an example where company X provides its employee, A, with air transportation. Employee A also serves on the board of directors of company Z, and company Z regularly purchases a significant amount of goods and services from company X. Because of the relationship between company Z and A’s employer, A’s membership on company Z’s board of directors is related to A’s trade or business of being an employee of company X. Accordingly, this flight can be categorized as business and excluded from income to A as a working condition fringe. This exemplifies that a “business” flight can encompass flights taken for another company whose business is substantially related to the company’s trade or business. Notwithstanding the regulation’s example, however, whether a business is substantially related to the company’s trade or business can be a source of friction between the IRS and the taxpayer.

The increase in aircraft audits on high-net-worth individuals, large corporations and complex partnerships is a part of the IRS’s new initiative using Inflation Reduction Act funding to expand its enforcement efforts. Commissioner Werfel stated that “the IRS continues to increase scrutiny on high-income taxpayers as we work to reverse the historic low audit rates and limited focus that the wealthiest individuals and organizations faced in the years that predated the Inflation Reduction Act. We are adding staff and technology to ensure that the taxpayers with the highest income, including partnerships, large corporations and millionaires and billionaires, pay what is legally owed under federal law.”

Pillsbury continues to closely monitor the IRS’s increased efforts in auditing high-net-worth individuals, large corporations and complex partnerships, including its new focus on corporate aircraft audits for these taxpayers. While a properly structured and tax-compliant corporate aircraft can result in significant tax savings, navigating the regulatory requirements can often be complicated and numerous issues can arise on audit. Taxpayers, particularly those coming under the focus of the new IRS initiatives, should be mindful of the various risks they may encounter and continue to work closely with their tax advisors to assess their current and proposed aircraft tax reporting positions in the event of an audit.