Final Regulations Issued On Deductions For Entertainment Use Of Corporate Jets

The IRS recently released final regulations addressing the tax treatment of the entertainment use of business aircraft. This regulation package adds new Treas. Reg. Secs. 1.274-9 and -10, which adopt, with some changes, proposed regulations issued in 2007.

Under Treas. Reg. Sec. 274-10, expenses that are subject to disallowance because of entertainment use of aircraft include both variable (direct) costs such as fuel and landing fees, and fixed (indirect) costs such as depreciation, hangar fees and pilot salaries. Additionally, interest expense is subject to disallowance if the underlying debt is secured by, or can be properly allocated to, an aircraft used for entertainment. Taxpayers are permitted to aggregate expenses for certain aircraft of similar cost profiles to calculate expenses subject to the disallowance.

Many practitioners hoped the final regulation would include a primary purpose test for identifying disallowed expenses. Under such a test, if the flight was primarily for business purposes, only the incidental additional costs associated with the entertainment passengers would be disallowed. The IRS did not, however, adopt a primary purpose test and instead retained the two allocation methods provided in the proposed regulations. Taxpayers may use either the occupied seat hours method or the miles allocation method. These methods divide the total expenses for the year by either the number of occupied seat hours or occupied seat miles to determine a per-seat or per-mile rate, and apply the rate to the number of hours or miles of entertainment use.

The regulation also permits taxpayers to elect to compute depreciation on a straight-line basis for all of the taxpayer's aircraft for all years, even if the taxpayer uses another method to compute depreciation for other purposes. Transition rules are included for applying the straight-line election aircraft placed in service in taxable years prior to the election and provide that in any taxable year the depreciation disallowance does not exceed the amount of otherwise allowable depreciation.

Treas. Reg. Sec. 1.274-10 also provides rules related to reimbursed expenses, deadhead flights, leases to third parties, travel on regularly scheduled commercial airlines and charitable contribution deductions.

Treas. Reg. Sec. 1.274-9 includes rules related to entertainment provided to specified individuals, which outline exceptions to the disallowance of expenses for entertainment, amusement or recreation activities, or for an entertainment facility. Employers' entertainment expense deductions are not disallowed to the extent they are included in the taxable income of specified individuals. The amount disallowed is also reduced by any amount for which the specified individual reimburses a taxpayer for entertainment. A specified individual includes an officer, a director or an owner of more than 10 percent of a corporation or a comparable person as defined in the regulation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Grant Thornton's Washington National Tax Office Grant Thornton LLP 1250 Connecticut Avenue, NW - Suite 400 Washington, DC DC 20036 UNITED STATESE-mail: [email protected] URL: www.grantthornton.com

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