On February 21, the IRS announced a new campaign to increase audits of private jet usage by high-income taxpayers, large corporations, and large partnerships to ensure that business deductions for such usage have been properly made. The announcement is consistent with an ongoing IRS publicity campaign urging increased scrutiny of high-net-worth taxpayers in the wake of media criticism of increasing wealth inequality in the U.S. and follows in the footsteps of IRS announcements in September 2023 that Inflation Reduction Act funding would be used to target the top 1% of taxpayers. The IRS has focused on high-net-worth taxpayers through prioritization of high-income audit cases, use of artificial intelligence to target large partnership returns, expanded efforts to curb digital currency and foreign bank account non-compliance, and the creation of a special IRS unit focused on auditing pass-throughs owned by the ultra-wealthy. At the announcement for this newest campaign, IRS Commissioner Danny Werfel commented, "These aircraft audits will help ensure high-income groups aren't flying under the radar with their tax responsibilities."
While this latest campaign is in its infancy, now is the time for private jet owners — whether individuals, corporations, or partnerships — to work with their tax advisors to ensure proper compliance and reporting.
Background
Business use of private jets has long been a fixture of the corporate executive world and remains a point of fascination for the public. The premise of deductions for business use of private jets is relatively straightforward. Under I.R.C. § 162(a), taxpayers can deduct ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, meaning that private jet costs associated with business activities can be deducted. However, muddying the waters are highly complicated legal requirements that business users of private jets allocate expenses between business use and personal use. Not only is tracking difficult and costly, but the rules and regulations defining use of jets and how to allocate time are murky and broad.
For example, under Treas. Reg. § 1.162-2(b), if a taxpayer travels to a destination and, while at the destination, engages in both business and personal activities, travel expenses to and from such destination are deductible only if the trip is related primarily to the taxpayer's trade or business. If the trip is primarily personal in nature, the travel expenses to and from the destination are not deductible even though the taxpayer engages in business activities while at such destination. However, expenses while at the destination which are properly allocable to the taxpayer's trade or business are deductible even though the traveling expenses to and from the destination are not deductible. This "primary purpose test" is a facts and circumstances test that is tough for taxpayers to apply and often even more difficult for accountants to track. So, hypothetically, while Taylor Swift's private flight from the AFC Championship Game to perform in Japan would be deductible as a business expense, her private flight from Japan to Las Vegas to attend the Super Bowl, as a personal activity, would not be so deductible.
Perhaps surprising in light of the new IRS audit campaign, recent IRS publications have actually given some reprieve to private jet owners looking to maximize business use deductions. In particular, the IRS has offered sole proprietor businesses an easier route to determining deductibility of expenses for use of their private jet. In IRC Memorandum 202117012 (April 2021), the IRC Chief Counsel's office concluded that a sole proprietor that owns an aircraft (either directly or indirectly through a disregarded entity) may use the primary purpose test in Treas. Reg. § 1.162-2(b)(1) to determine whether expenses for use of the aircraft by the sole proprietor are deductible, rather than the more arduous method of tracking and allocation of seat hours or miles flown as provided in Treas. Reg. § 1.274-10(e).
Apart from scrutinizing deductions for business use of private jets, it is anticipated that IRS audits will focus on other tax-efficient strategies owners use for generating deductions from their private jets. One such creative tool is the donation of a private jet, or use of a private jet, to a nonprofit organization. Under I.R.C. § 170, a deduction is allowed for the fair market value of charitable contributions. If a charitable contribution is made in property other than money, the amount of the contribution is generally the fair market value of the donated property at the time of the contribution, reduced by certain exclusions. Jet owners and fractional jet owners can get creative with charitable contributions surrounding their jets. For example, private jet owners and fractional private jet owners may donate flight hours to a medical nonprofit organization for the transportation of patients in need. Similarly, private jet owners looking for an alternative to selling their jet may look to donation of the jet itself to a charitable organization. There are additional compliance risks and reporting obligations when jet owners donate (or attempt to be reimbursed for) the use of their private jet by the jet owner's private foundation. With its new campaign, the IRS may be on the lookout for noncompliance in charitable giving within the private jet market.
Impact and Response
The IRS campaign to increase private jet audits has immediate implications for private jet owners. In the near term, owners of private jets should assume that they are at high risk of audit by the IRS. Owners that have not adequately prepared documentation to defend their deductions for business use of private jets will need to act quickly to work with their tax advisors to ensure proper records can be located and supported in the event of an IRS audit. Similarly, owners who have made charitable donations related to private jets should work with their tax advisors to be prepared to defend any donation to a nonprofit organization. This includes working with their tax advisors to ensure the proper documentation is in place, such as a deed of gift, a qualified appraisal, a Form 1098-C from the recipient organization, and a contemporaneous written acknowledgment of the contribution from the donee to the donor, in addition to any situation-specific documentation. Finally, in the near term, owners will want to work with their tax advisors to ensure that the ownership of their private jet is structured properly to allow deductions to be taken by the intended entity or individual.
In the long run, current owners will need to focus on closely complying with IRS statutory guidelines, Treasury regulations, and case law surrounding ownership, operation, and charitable donation of their private jets. Similarly, new owners will want to ensure tax efficient structuring for any new jet purchase, as well as maintenance of accurate tracking and tax reporting systems for business use of their private jet or charitable contributions.
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