Deductions for Entertainment Use of Business Aircraft; Federal Register Extracts

SUMMARY: This document contains final regulations relating to the use of business aircraft for entertainment. These final regulations affect taxpayers that deduct expenses for entertainment, amusement, or recreation provided to specified individuals. The final regulations reflect statutory amendments under the American Jobs Creation Act of 2004 (AJCA) and the Gulf Opportunity Zone Act of 2005 (GOZA).

DATES: Effective Date: These regulations are effective August 1, 2012.

Applicability Date: For dates of applicability, see SUBSEC 1.61-21(g)(14)(iii), 1.274-9(e), and 1.274-10(h).

FOR FURTHER INFORMATION CONTACT: Michael Nixon (section 274), (202) 622-4930; or Lynne A. Camillo (section 61), (202) 622-6040 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains final amendments to the Income Tax Regulations, 26 CFR part 1, relating to the disallowance under section 274 of the Internal Revenue Code (Code) of deductions for the use of business aircraft for entertainment.

On June 15, 2007, a notice of proposed rulemaking (REG-147171-05) regarding the use of business aircraft for entertainment was published in the Federal Register (72 FR 33169). Written and electronic comments responding to the notice of proposed rulemaking were received. A public hearing on the proposed regulations was held on October 25, 2007. After consideration of all the comments, the proposed regulations are adopted as amended by this Treasury decision. The comments and revisions are discussed in the preamble.

Explanation of Provisions and Summary of Comments

1. Determination of Costs

a. Application of Disallowance to Fixed Costs

The proposed regulations provide that expenses subject to disallowance under section 274(a) include variable costs such as fuel and landing fees, and fixed costs such as depreciation, hangar fees, pilot salaries, and other items not directly related to an individual flight. Commentators suggested that the final regulations should limit expenses subject to disallowance to the direct or variable costs of a flight and exclude fixed costs. The final regulations do not adopt this comment because section 274(e)(2) does not explicitly differentiate between fixed and variable expenses and because such an interpretation is contrary to Congressional intent.

b. Charter Rate Safe Harbor

The proposed regulations requested comments on whether, as an alternative to determining actual expenses, the final regulations should allow taxpayers to determine the amount of expenses paid or incurred for entertainment flights by reference to charter rates. The proposed regulations asked for specific comments on the availability of substantiated actual, published, undiscounted charter rates charged to the general public by companies that meet certain requirements.

Commentators generally endorsed the inclusion of a charter rate safe harbor in the final regulations. They suggested that the IRS establish rates either by conducting a survey of average charter rates by region or by authorizing representatives of the industry to create a charter rate reporting system. One commentator suggested that if the IRS does not establish charter rates, individual taxpayers should be allowed to determine charter rates. Commentators also stated that a charter rate safe harbor should include rates for rentals of small piston aircraft, which taxpayers use extensively for business but normally are not chartered.

The difficulty of determining accurate and reliable charter rates continues to be an impediment to establishing a charter rate safe harbor. Accordingly, the final regulations do not include these rules. However, the final regulations authorize the IRS to adopt charter rate or other safe harbors in future published guidance, see SEC 601.601(d).

c. Depreciation

The proposed regulations permit a taxpayer to elect to compute depreciation expenses on a straight-line basis for all of the taxpayer's aircraft and all taxable years for purposes of calculating expenses subject to disallowance, even if the taxpayer uses another method to compute depreciation for other purposes. The proposed regulations provide a transition rule for applying the straight-line election to aircraft placed in service in taxable years preceding the election, which requires the taxpayer to apply the straight-line method as if it had been applied from the year the aircraft was placed in service.

A commentator requested that the final regulations allow a separate election for each aircraft. The final regulations do not allow an aircraft-by-aircraft election. Requiring taxpayers to make the election for all aircraft appropriately balances the policies of promoting business investment through the allowance of additional first-year depreciation and denying a tax benefit for entertainment use of business aircraft.

The commentator also suggested that changing depreciation methods under the transition rule may result in disallowing more than 100 percent of the cost of the aircraft. In response to the comment, the final regulations clarify that, in any taxable year, the depreciation disallowance does not exceed the amount of otherwise allowable depreciation. Thus, the sum of the allowable depreciation and the depreciation disallowed will not exceed 100 percent of basis, regardless of the taxable year a taxpayer makes the straight-line election.

The final regulations provide examples illustrating how taxpayers determine depreciation and basis under the election.

d. Interest Expense

A commentator asked for clarification on whether interest is an expense that is subject to disallowance. In response to this comment, the final regulations clarify that interest is subject to disallowance if the underlying debt is secured by or properly allocable to an aircraft used for entertainment.

e. Aircraft Aggregation

The proposed regulations provide that a taxpayer may aggregate expenses for aircraft of similar cost profiles to calculate expenses subject to disallowance. The proposed regulations require that aircraft have the same engine type and number and suggest other factors relevant to whether aircraft are of a similar cost profile.

A commentator requested that the final regulations make the aircraft aggregation rules less restrictive. The commentator opined that taxpayers should be allowed to aggregate the expenses of all aircraft to alleviate the administrative burden of computing and allocating expenses to entertainment use of the aircraft. The commentator stated that, alternatively, the rules inappropriately require similar cost profiles to include the same number of engines and require an unduly detailed analysis of the aircraft characteristics.

The final regulations retain the aircraft aggregation rules. Aggregating the expenses of all aircraft regardless of cost characteristics would create unacceptable distortions in the amount of expenses allocated to the use of each aircraft. The rules are sufficiently broad and flexible for taxpayers to easily apply them.

2. Allocation of Costs to Flights

a. Primary Purpose Test

The proposed regulations provide two alternative methods for allocating the costs associated with the use of an aircraft to provide entertainment to specified individuals. The occupied seat hours or miles allocation method divides the total expenses for the year by the number of occupied seat hours or occupied seat miles to determine a per seat or per mile rate, and it applies the rate to the number of hours or miles of entertainment use. The flight-by-flight method allocates expenses to a flight and then to the passengers on the flight according to the entertainment or nonentertainment character of the travel.

Commentators suggested that the final regulations adopt a primary purpose test for identifying disallowed expenses. Under a primary purpose test, the primary purpose of a flight would determine whether any costs associated with specified individuals traveling for entertainment on that flight are disallowed. Generally, if the primary purpose of a flight is business, no more than the additional or incidental costs associated with specified individuals traveling for entertainment aboard that flight would be disallowed. Some commentators suggested that if the primary purpose of a flight is business, no costs should be allocated to entertainment. One commentator advocated that the final regulations include a primary purpose test as a safe harbor for smaller aircraft.

The final regulations do not adopt a primary purpose test. Section 274(e)(2) applies if a taxpayer provides entertainment, amusement, or recreation to a specified individual and does not depend on either the reason the taxpayer provides the entertainment or the overall use of the aircraft. Disregarding entertainment use by a specified individual is contrary to Congressional intent in amending section 274(e)(2) to disallow expenses allocable to entertainment use of aircraft by specified individuals.

b. Effect of Allocation Rules

Commentators suggested the passenger-by-passenger allocation of costs in the proposed regulations imposes an undue administrative burden on taxpayers. One commentator stated that the regulations result in excess disallowance and are unworkable due to their inconsistency with the primary purpose test. Another commentator said that determination of the character of each passenger's use could be difficult and asked for more examples illustrating when a use is entertainment.

--This is a summary of a Federal Register article originally published on the page number listed below--

Final regulations.

CFR Part: "26 CFR Part 1"

RIN Number: "RIN 1545-BF34"

Citation: "77 FR 45480"

Document Number: "TD 9597"

Federal Register Page Number: "45480"

"Rules and Regulations"