Corporate Jet Audits: What the IRS Is Looking For

The IRS’ recent announcement of a crackdown on corporate jet usage garnered national attention as the Biden administration continues down its path of increasing audit scrutiny of wealthy individuals and large businesses with complex tax structures. Zeinat Zughayer, tax controversy manager with Baker Tilly, gave insights on the impetus behind the new series of audits and their scope.

On February 21, the IRS announced plans to initiate dozens of new audits focusing on the allocation between business and personal use of corporate aircraft by executives, partners, shareholders, and others for tax purposes. The extent of personal usage “impacts eligibility for certain business deductions,” the IRS said. “Use of the company jet for personal travel typically results in income inclusion by the individual using the jet for personal travel and could also impact the business’s eligibility to deduct costs related to the personal travel.”

By the IRS’ admission, this area of the Code is complicated, and the agency has lacked sufficient enforcement resources until the enactment of the Inflation Reduction Act (PL 117-169) to make sure personal use of business aircraft isn’t recorded for tax write-offs.

Zughayer told Checkpoint in an interview that in her experience, corporate aircraft usage has been “a focal point” of examination for clients under audit and is something she would “expect the IRS to focus on,” since it has “always been … a hot topic issue.” It makes sense, then, for the IRS to include the area as part of the larger audit campaign, which includes an emphasis on complex partnerships and millionaires.

“I do feel like there’s been an uptick in purchases of corporate aircrafts since COVID,” Zughayer added. “So maybe they’re also seeing it more frequently.”

Bonus depreciation is a popular deduction claimed for corporate jets, one that the IRS looks at closely during an audit, “even if you’re taking straight-line accounting for any personal usage” and subtracting the personal usage from the deduction, she said. “There’s also this other side of imputing income … like reimbursing the company when there is an employee that’s using the aircraft for personal use, whether that be for entertainment purposes or non-entertainment purposes.”

Code Sec. 280F governs bonus depreciation eligibility for aircraft and was created to deter the practice of taxpayers buying an aircraft, putting it in a separate limited liability company, and leasing it back to themselves as part of a rental business while writing off all personal use, Zughayer explained. Under Code Sec. 280F, each flight must meet a qualified business use threshold of 50.1% to qualify for bonus depreciation, and 25% of the business use “has to be use that’s just not renting [the aircraft] to yourself or any related party.”

Flights tend to be classified as: business, business entertainment, personal non-entertainment, or personal entertainment. The IRS will especially home in on deductions claimed for personal non-entertainment flights, like if an employee attends a funeral or meets with a financial advisor outside of the operating business, Zughayer said. In the agency’s view, it is a sort of “imbalance” when a business imputes income to that employee at a rate “significantly less than the fair market value of that flight.” If only $1,500 is imputed for a $20,000 flight, for example, the business can still take a $20,000 deduction.

Zughayer commented she is interested to see what “new methods” the IRS will try to use to “push back on that,” since the rules are written in a way that “simply allows for a taxpayer-favorable position.”

Allocations of mixed-use flights “can be very subjective,” she said, so the first question she asks clients is what the primary purpose of a flight was. For instance, if an employee flies to Las Vegas for a conference but brings their spouse along to stay in the city for the weekend after the work event, the primary purpose would still be classified as a business trip. In that scenario, income would be imputed for the benefit of having the spouse fly with the employee. By contrast, for flights classified as entertainment, costs are allocated by passenger.

This distinction could matter “because imputing $1,500 to an employee for having their spouse on the flight could be very different than having to allocate $10,000 to each passenger and potentially disallowing $10,000 worth of deductions,” Zughayer clarified.

She warned that recordkeeping and substantiating claims comes with its own challenges. If the taxpayer who attended Las Vegas conference is audited, a complete flight log may not be enough. In one case, Zughayer had an IRS agent ask for a conference pamphlet as supporting documentation to prove that was what the flight was for.

“These exams aren’t usually done the year after the return is filed,” Zughayer said. “You might be asking a taxpayer to go back two to three years in their email to find something to support the flight that they took two or three years ago. So that’s where documentation can become challenging, and what we try to do is just get best practices in place from the beginning.”