Notice 2005-45: The IRS Takes Aim at
Executives’ Entertainment Use of Company Aircraft
By Marianna G. Dyson and C. Frederick Oliphant III
Some might say that it is a classic case of the revenge
entertainment activity. Section 274(e)(2) provides in very
of the nerds. As a result of the legislative change to section
general terms that the bar on deduction of entertainment
274(e)(2) of the Internal Revenue Code in the American Jobs
expenses in section 274(a) will not apply to expenses that
Creation Act of 2004 (AJCA), the same able lawyers within
are reported as compensation to the employee.
IRS Chief Counsel who had unsuccessfully advocated the
Section 274(e)(2) of the Code was the centerpiece of the
government’s position in Sutherdispute in Sutherland, which inland Lumber-Southwest, Inc. v.
volved the taxpayer’s deduction
Commissioner1 found themselves
of expenses for its executives’
MARIANNA G. DYSON and C. FREDERICK
empowered to write guidance
entertainment flights on comOLIPHANT III are members of the Washingimplementing the new deduction
pany aircraft that were valued
ton law firm of Miller & Chevalier Chartered.
disallowance with respect to such
for compensation purposes usThey write and speak frequently about issues
expenses. In May of this year,
ing the special valuation rules
relating to executive compensation and emthe Internal Revenue Service
for flights on noncommercial
ployee benefits. They gratefully acknowledge
(IRS) released Notice 2005-45,2
aircraft. At issue was whether
the assistance of Michael M. Lloyd and Dwight
which, if nothing else, clearly
section 274(e)(2) (before its
N. Mersereau in preparing this article.
communicates to taxpayers who
2004 amendment) allowed the
the real winners of the case ulemployer to deduct all the extimately were.
penses related to the executives’
But Notice 2005-45 is more than that. Because of its
personal use of the corporate aircraft, even though the
method of pro rata allocation of aircraft expenses based
value of the personal trips for compensation purposes that
on passenger use, Notice 2005-45 goes well beyond simply
was reported as income to the executives was less than the
reversing the Sutherland. In its apparent zeal both to issue
cost of providing the trips.4 The Tax Court held that if a
guidance quickly and also to change company behavior by
plane is an “entertainment facility” potentially subject to
imposing a deduction disallowance on all “entertainment”
deduction disallowance under section 274(a) of the Code,
use of company aircraft by “specified individuals,” the
then section 274(e)(2) operates as an exception, as long as
IRS conjured a methodology for allocating expenses to
the value of the personal use of the aircraft is properly imany entertainment use that can yield surprising results.
puted to the employee and reported as compensation on the
Moreover, the IRS left open a number of questions of how
company’s return. In Sutherland, the taxpayer had used
this methodology is to be applied and how it interacts with
the special valuation rules applicable to flights on noncomthe historical body of law surrounding fringe benefits, the
mercial aircraft under Treas. Reg. § 1.61-21(g) (known as
valuation and deduction treatment of travel expenses, inthe Standard Industry Fare Level or SIFL rules) to detercluding the application of section 274 of the Code, and the
mine the value of the executives’ entertainment trips. The
accelerated depreciation rules.
result was that the expenses deducted by the company far
This article summarizes the main points of the Notice,
exceeded the income imputed to the executives.
which took effect on July 1, with particular attention to the
Effective for expenses incurred after October 22, 2004,
issues raised by the new expense allocation method and its
section 907 of the AJCA revised section 274(e)(2) to limit
application.
the deduction for expenses for entertainment goods, services
and facilities (including airplanes used for certain personal
I. Background
reasons) provided to “specified individuals” to the amount
that the company treats as compensation to the recipient
and reports as compensation on its corporate return.5 In
A. Pyrrhic Victory in Sutherland
other words, in the case of a “specified individual,” the
Reacting with indignation to the taxpayer’s victory
amount of the company’s deduction for entertainment is
in Sutherland (and to media reports of excessive execulimited to the amount treated as wages for income tax
tive use of corporate aircraft for personal purposes), in
withholding purposes with respect to the employee receiv2004 Congress amended section 274(e)(2) of the Code to
ing the entertainment goods, services, or facilities or, in
staunch the perceived abuse.3 Section 274(e)(2) operates
the case of a director or other independent contractor, the
as an exception to the general deduction disallowance rule
amount reported as compensation income on a Form 1099applicable to entertainment expenses in section 274(a) of
MISC. Moreover, these amounts must be reported on the
the Code. Section 274(a) limits the deductibility of expenses
company income tax return as compensation.6 Although
otherwise deductible under section 162, barring the deducthe amendment was “intended to overturn the decision in
tion of expenses for (i) an activity generally considered to
Sutherland,”7 the restriction on deductibility now codified
be entertainment, amusement, or recreation, unless the
in section 274(e)(2) is not limited to expenses attributable
taxpayer proves that the expense is directly related to
to corporate aircraft and has a much broader reach, includor, in certain cases, associated with the taxpayer’s trade
ing potentially the personal use of automobiles. Moreover,
or business, or (ii) a facility used in connection with such
in its current form, it could be extended to other expenses
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Notice 2005-45: The IRS Takes Aim at Executives’ Entertainment Use of Company Aircraft
already addressed in section 274, including (a) the 100-percent deduction disallowances applicable to spousal travel
and luxury cruises and (b) the 50-percent deduction disallowance applicable to business meals and entertainment,
thereby forcing a deduction disallowance with respect to
any affected expenditures that exceed the value treated as
compensation paid to the specified individual.
B. Congress Is “Shocked, Shocked” to Find a
Mismatch between Deduction and Income
the AJCA Conference Report offers the following example of
how new section 274(e)(2) should operate to disallow all or
a portion of the expenses associated with using the aircraft
for entertainment purposes:
For example, a company’s deduction attributable
to aircraft operating costs for a covered employee’s
vacation use of a company aircraft is limited to
the amount reported as compensation to the employee.13
Congress’s motivation in amending section 274(e) is reIn other words, the legislative history illustrates the situaflected in the conference report on the AJCA as concern over
tion in which the executive controls the destination of the
the arbitrage aspect of the mismatch between the income
aircraft and, pursuant to that control, uses the aircraft for
reported for personal flights (when the flights are valued
an entertainment purpose, that is to say, a vacation.
using the SIFL rules) and the deductibility of
the costs associated with providing such taxable fringe benefits.8 The conference report
In contrast to the conference report’s single example of
expresses seeming surprise about this mismatch — “a deduction multiple times larger
vacation use of the company aircraft and the methodology
than the amount required to be included in
used by the government and the taxpayer in Sutherland,
income” — though there is no doubt that this
potential for mismatch was clearly understood
Notice 2005-45 does not employ a flight-by-flight analysis
and acknowledged by Congress 20 years ago
in allocating aircraft costs to entertainment use, whereby
when the SIFL rules for income imputation
were first introduced.9
C. Historical Treatment of Fringe
Benefit Value and Costs — “East
Is East and West Is West”
the first inquiry would be to determine the purpose of
the flight, followed by a determination of who was on the
flight and for what purpose.
This mismatch or lack of correlation between the (i) value of the fringe benefits for purposes of
imputing income to employees and independent contractors and (ii) the cost of the fringe benefits to the employer
for deduction treatment has been clearly recognized, and
even required, in the fringe benefits regulations. The fringe
benefit regulations specifically provide that cost is irrelevant when determining the value of a fringe benefit to be
taxed to the employee or independent contractor,10 while
mandating that the employer may only deduct the cost (not
the value) of a fringe benefit.11 In no event, under these
rules, may the amount of the deduction exceed the actual
cost of providing the benefit, even if the value of the fringe
benefit included in the service provider’s income is greater
than the cost of providing the benefit.12
D. What Congress Did (and Didn’t Do)
in the AJCA
With the AJCA amendment to section 274(e)(2),
Congress altered this approach and provided a limited
exception, in the case of “specified individuals,” to the rule
that deductions for the cost of providing fringe benefits to
recipients are conceptually separate and distinct from the
value of the benefit that is included in the recipients’ income.
In so doing, Congress eliminated any risk of a company’s
deducting more in entertainment expenses than the amount
imputed in the specified individual’s compensation.
In describing congressional concern about the mismatch
between income and deduction inherent in the Sutherland
case and the intent to overturn the Tax Court’s decision,
JULY-AUGUST 2005
It is important to note, however, what Congress did not
do. The legislative history does not identify as an abuse
the situation in which the aircraft is flying for bona fide
business purposes, and a specified individual happens to
“hitchhike” a ride on the aircraft for personal purposes.14
Nor does it identify as abusive the situation in which the
executive is flying for business purposes, and his or her
spouse flies along for personal purposes. In both of these
cases, the plane is flying for business purposes, and allowing the hitchhiker or the guest of the specified individual
to board the flight results in little or no incremental cost to
the company. 15 Thus, it may be argued that in amending
section 274(e)(2), Congress did not purport to revise what
constituted entertainment use of corporate aircraft or to
create a new method for determining what expenses are
attributable to entertainment.
In other words, Congress did not intend the exception in
section 274(e)(2) to become more powerful than the general
disallowance rule of section 274(a).
II. Analysis of Notice 2005-45
A. The IRS’s Determination of Expenses
Allocable to Entertainment Use — Rational
Method or Flying by the Seat (of its Pants)?
In contrast to the conference report’s single example of
vacation use of the company aircraft and the methodology
used by the government and the taxpayer in Sutherland,
Notice 2005-45 does not employ a flight-by-flight analysis
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Notice 2005-45: The IRS Takes Aim at Executives’ Entertainment Use of Company Aircraft
in allocating aircraft costs to entertainment use, whereby
the first inquiry would be to determine the purpose of the
flight, followed by a determination of who was on the flight
and for what purpose. This is surprising, inasmuch as a
flight-by-flight approach would, at least at first blush, be
more intuitively appealing for apportioning costs with respect to a company’s use of an aircraft, particularly since the
number of passengers on a specific flight would not seem to
materially change the operating costs of the aircraft during
the taxable year.
Instead, the Notice adopts an occupied-seat analysis,
which effectively prorates the cost of maintaining and operating the costs of the aircraft among all aircraft passengers. It directs companies to base their determination of
the expenses allocable to entertainment use of the aircraft
by tracking and aggregating all expenses attributable to
its maintenance and operation (i.e., all fixed and operating costs) for the year and dividing these total expenses
by either occupied seat hours or occupied seat miles flown
by the aircraft in order to come up with the cost of each
occupied seat hour or mile for the entire year.16 Once the
occupied seat hour or mile cost is determined for the year,
that cost is multiplied by the number of entertainment
seat hours or miles for the year; the amounts treated as
compensation or reimbursed by the specified individual are
then subtracted to come up with the total expenses to be
disallowed for the year.
To illustrate, assume that pursuant to the Notice the
taxpayer uses occupied seat hours as its unit of measurement and that the company aircraft is flown from Atlanta
to New York and back with a full load of 10 passengers,
and is in the air 2-1/2 hours each way. Under the Notice,
this 5-hour flight by 10 employees yields 50 occupied seat
hours. If this flight is the only flight for the taxable year
and the total fixed and variable costs of the aircraft are
$100,000, each occupied seat hour would have a value of
$2,000. Further assume that 6 of the 10 passengers are
traveling for bona fide business purposes and the remaining 4, who consist of a specified individual and 3 family
members, are traveling for personal purposes. Because the
value of the 4 passengers’ personal trips is deemed to be
zero under the 50-percent regular seating capacity rule of
Treas. Reg. § 1.61-21(g)(12), nothing is imputed in income
for the personal trips and, for purposes of this example, it
should also be assumed that nothing is reimbursed to the
taxpayer by the specified individual with respect to these
personal trips.
Under these facts, the costs attributable to 20 occupied
seat hours would be disallowed (20 x $2,000 = $40,000),
since no compensation was included in the specified individual’s wages and no reimbursements were made to the
company. This is the result under the Notice, even though
the aircraft was flying to New York for business purposes
in any event, and even though, had the specified individual
and the three family members not hitchhiked a ride, the
entire cost of the flight would have been deductible.
Likewise, the Notice’s occupied-seat approach skews
the calculation of the deduction disallowance for the year
in any situation in which the specified employee’s spouse
flies along on a business trip. For example, assume that all
the flights by the company’s aircraft for the year would be
considered business trips by the executive under a flight348
by-flight analysis. If the spouse accompanies the executive
on every business trip as the only other passenger, and
the company imputes the value of the spouse’s trips in the
executive’s income using the SIFL rules, one-half of the
aircraft costs for the year, less the amounts included in the
executive’s compensation attributable to the spouse’s travel,
will be disallowed, even though the airplane was, on these
facts, flying for business purposes and the company likely
incurred very little or no extra expenses for the spouse’s
travel.
The Notice’s method of allocating expenses on a prorata basis has a random, unpredictable aspect, in that
it apportions airplane cost to passengers on an equal
basis, no matter whether all the passengers are on the
same flight or on separate flights. This method ensures
that any use of a company aircraft for entertainment
purposes will potentially result in some lost deduction
by the company, even if that use does not incrementally
affect or increase costs. Thus, if companies do not want
to lose deductions for their corporate aircraft, the Notice’s
methodology will prompt them into adopting a total ban on
any entertainment use by specified individuals (whether
or not the use would otherwise affect their aircraft costs).
Short of that, companies wishing to minimize the impact
of the Notice’s methodology will have an incentive to make
sure that when the aircraft flies for business purposes, every seat on the plane is, to the extent possible, filled with
a business passenger.
The Notice ends speculation over the treatment under
the new law of regularly scheduled flights between business centers where specified individuals are on board for
personal/entertainment purposes, as well as flights by
executives who are required to fly on the company aircraft
because of security concerns.17 It specifically provides that
the costs associated with those flights are subject to the
disallowance provisions of section 274(e)(2) of the Code.
Thus, the Notice rejects any argument that these flights
are implicitly non-entertainment flights.
B. “That’s Entertainment!” or Is It?
One of the most disappointing aspects to the Notice
is its failure to provide any additional insight into either
the meaning of “entertainment” or when a transportation
facility (such as an aircraft) is being used for entertainment
purposes and the consequences of such use. The Notice
effectively defaults to the definition of “entertainment” set
forth in Treas. Reg. § 1.274-2(b)(1), which has been in the
regulations since 1963 with little change. Notice 2005-45
describes “entertainment” as:
any activity of a type generally considered to constitute entertainment, amusement, or recreation,
such as entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs,
sporting events, and on hunting, fishing, vacation
and similar trips. Similar activities relating solely
to the taxpayer’s family also may constitute entertainment. Entertainment may include an activity
that satisfies the personal, living, or family needs
of an individual, such as providing food and beverages or a hotel suite to a business customer or the
THE TAX EXECUTIVE
Notice 2005-45: The IRS Takes Aim at Executives’ Entertainment Use of Company Aircraft
customer’s family. Entertainment does not include
activities, however, that are clearly not regarded as
constituting entertainment, such as the provision
of supper money by an employer to an employee
working overtime, the maintenance of a hotel room
by an employer for lodging of employees while in
business travel status, or the use of an automobile
in the active conduct of a trade or business even
though also used for routine personal purposes
such as commuting to and from work. Under
§ 1.274-2(b)(1)(ii), an objective test is used to determine whether an activity is of a type generally
considered to constitute entertainment.
Certainly, it appears that activities that would ordinarily be considered to be fun constitute “entertainment,”
but the definition quickly becomes muddled when it attempts to distinguish between personal benefits that rise
to the level of entertainment and those that do not. It is
an objective test, but the circuitous observation of Treas.
Reg. § 1.274-2(b)(1) that “[e]ntertainment does not include
activities, however, that are clearly not regarded as constituting entertainment” merely obfuscates at a time when
it is critical to be able to distinguish between entertainment and non-entertainment. For example, the Notice
paraphrases the statement in Treas. Reg. § 1.274-2(b)(1)(i)
that commuting use of an automobile does not rise to the
level of entertainment, but fails to answer the obvious next
question of whether commuting use of a company aircraft
by an executive would be viewed similarly.18 Nor does the
Notice offer additional insight into when or whether certain
activities or the usage of certain facilities could morph into
entertainment use, such as the use of a car for personal
use, other than for just commuting or routine use as noted
in the definition.19
The Notice does not conclude, however, that all personal
use of an aircraft is presumed to be entertainment or that
personal use converts the aircraft into an entertainment
facility. In fact, in its discussion of relief from the consistency rule (see Part II(I), below), the Notice acknowledges
that there may be a category of personal use by a specified
individual that does not rise to the level of “entertainment,”
but offers no guidance on what that use might be other
than the general observation that the determination is an
objective one. Moreover, the Notice does not cross-reference
the examples in the working condition fringe benefit rules
that permit exclusion for certain flights that appear to be
personal, but are deemed to be related to the employer’s
trade or business or to provide a substantial business benefit
to the employer.20
C. Forty Years in the Section 274 Wilderness
The Notice dredges up a number of questions about the
proper application of section 274 to transportation facilities
such as airplanes, which pre-date the changes made by
Congress in AJCA. Over the last 40 years, Congress has
responded to various perceived abuses involving entertainment by grafting specific anti-abuse rules upon section 274
and leaving it to the IRS to make sense of them. In some
insert CertCapture ad
p/u May-June 05
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JULY-AUGUST 2005
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Notice 2005-45: The IRS Takes Aim at Executives’ Entertainment Use of Company Aircraft
instances, the IRS was, for the most part, successful in
resolving the major issues that emerged after Congress inserted a particular anti-abuse rule — such as when guidance was issued on spousal travel and club dues — but in
other instances, the guidance left open as many questions
as it answered. One lurking issue that is highlighted by
the Notice is how section 274(a) applies when a corporate
aircraft is used to fly employees to an activity that would
constitute entertainment, but for the fact that it qualifies
as an item directly related to the active conduct of a trade
or business. Assuming the entertainment, such as taking
customers to the Super Bowl, can be tied directly to the
taxpayer’s trade or business, the question is whether, under Treas. Reg. § 1.274-2(b)(1)(iii)(c)(1), the aircraft in that
particular instance is to be treated as an entertainment
facility, triggering denial of the deduction for costs associated with it, or whether the aircraft nonetheless remains a
transportation facility in such instance but with the costs
associated with the flight being treated as expenditures in
connection with section 274(a).
One of the more administratively troubling aspects of the Notice is the rule
designed to capture the costs associated
with “deadhead flights.”
The IRS does not appear to have taken a formal position on this question, so it is not clear how it will respond
to the issue, though one guess is that the IRS would shy
away from treating the aircraft as an entertainment facility,
except perhaps in the most extreme cases. Certainly that
interpretation (i.e., not treating the aircraft as an entertainment facility) would more likely accord with how companies
have probably treated such flights in the past.
D. Specified Individuals — The “Happy Few”?
A “specified individual” is defined by amended section
274(e)(2)(B)(ii) as any individual who is subject to the
reporting requirements of section 16(a) of the Securities
Exchange Act of 1934 or would be subject to those requirements if the provider of the benefit were publicly traded. In
most instances, even for very large corporations, the official
list of individuals subject to these reporting requirements
is not very long. The Notice, however, has expanded the
definition to include every person who:
(a) is the direct or indirect beneficial owner of more than
10 percent of any class of any registered equity security
(other than an exempted security),
(b) is a director or officer of the issuer of the security,
(c) would be the direct or indirect beneficial owner of more
than 10 percent of any class of a registered equity security if the taxpayer were an issuer of equity securities,
or
350
(d) is comparable to an officer or director of an issuer of
equity securities.
As explained by the Notice, a specified individual is an officer, director, or more than 10-percent owner of a corporation
taxed under subchapter C or subchapter S of the Code, or
a personal service corporation. For partnership purposes,
a specified individual includes any partner holding more
than a 10-percent equity interest, general partner, officer,
or managing member of a partnership. The definition also
includes a director or officer of a tax-exempt entity. Moreover, the specified individual is the recipient of the entertainment provided to a spouse, family member or another
person because of the person’s relationship to the specified
individual, and all entertainment costs are allocable to that
specified individual.21
The Notice also has a “related party” rule whereby the
disallowance provisions apply to the use of an aircraft for
the entertainment of a specified individual of a party related to the taxpayer within the meaning of section 267(b)
or 707(b) of the Code. Thus, if Corporations A and B are
brother-sister subsidiaries and Corporation A provides an
entertainment flight to B’s employee S, who is a specified
individual, A’s costs will be disallowed, except to the extent
the benefit is treated as compensation to S or reimbursed
by S. The Notice is silent on who would be responsible for
treating the personal trip as compensation in that situation,
but presumably B, the common law employer of S, would
be treated as the provider of the benefit for fringe benefits
purposes regardless of the fact that the other subsidiary
actually provided the benefit.22 Thus, B would have to inform A of the amount treated as compensation for purposes
of computing the amount that would be disallowed.
It appears that, in the case of large publicly held companies with many affiliates, the IRS is inclined to interpret
the definition of a specified individual broadly to include
officers of lower-tiered subsidiaries, even if those individuals are not subject to the reporting requirements of section
16(a). Informally, the IRS has indicated that the fourth
element of the general definition (i.e., a person who “is
comparable to an officer or director of an issuer of equity
securities”) means that officers of lower-tiered subsidiaries
of a publicly traded company, who are not likely to be listed
as 16(a) individuals, could be treated as specified individuals
simply because they are officers. It is unclear whether this
expansive interpretation is based on the IRS’s belief that
any officer within the corporate structure could effectively
“control” the use of an aircraft and, thus, if he or she takes
a personal trip (even if invited by an officer of the parent
corporation), the portion of the expenses attributable to the
flight are subject to the new limitations of section 274(e)(2)
of the Code. [In other words,] the Notice applies the definition mechanically, based on job titles, whereas section 16(a)
is designed to cover significant policy-makers (e.g., someone
who would be able to control the use of the aircraft). Such an
interpretation has the potential for expanding significantly
the administrative burden of the provision as well as the
size of the disallowance. For companies that allow corporate employees to hitchhike on corporate aircraft with open
seats, this interpretation will likely significantly increase
the cost of continuing such a policy.23
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Notice 2005-45: The IRS Takes Aim at Executives’ Entertainment Use of Company Aircraft
E.
Aircraft Ownership
The ownership of the aircraft is irrelevant for purposes of applying the rules of Notice 2005-45 to a specified
individual’s entertainment use of the aircraft. Therefore,
the costs of leased or chartered aircraft are also subject to
the disallowance rules, unless otherwise excepted, if the
provider of the benefit leases or charters the aircraft.
The allocation rules of the Notice become significantly
more difficult to administer in any situation in which the
owner of the aircraft has a separate charter business.
Presumably, the annual expenses of the aircraft would be
allocated between its use in the taxpayer’s general business
(including entertainment expenses) and its use in the separate charter business (i.e., when the aircraft is chartered
by others in an arm’s-length transaction).
F.
Types of Expenses Subject to Deduction
Disallowance
The types of expenses that, according to Notice 200545, must be included in the year-end allocation of allowable
and disallowed expenses consist of all fixed and operating
costs, including but not limited to —
•
•
•
•
•
•
•
•
•
•
•
•
fuel costs;
salaries for pilots, maintenance personnel, and
other personnel assigned to the aircraft;
meal and lodging expenses of flight personnel;
take-off and landing fees;
costs for maintenance and maintenance flights;
costs of on-board refreshments, amenities, or
gifts;
hangar fees (at home and away);
management fees;
depreciation;
amounts deductible under section 179;
all costs billed for chartering an aircraft (including
amounts for flight time, waiting time, fuel, and
overnight expenses); and
in the case of leased aircraft or other leased equipment, lease payments.
Interest and taxes on the aircraft do not appear to be
included in the list of expenses subject to allocation, presumably because they are deductible under other provisions
of the Code, even if the aircraft is used solely for personal
purposes.24 It is unclear why insurance expenses were not
included in this list, however.
G. Deadhead Flight Rule May Lead to Dead End
One of the more administratively troubling aspects of
the Notice is the rule designed to capture the costs associated with “deadhead flights.” Under the Notice, companies
must account for the costs associated with deadhead flights
in the total allocation of expenses. An aircraft “returning
empty from a flight after discharging passengers or traveling empty to pick up passengers” is defined as a “deadhead
flight,” which is deemed to have the same number and character of occupied seat miles or hours as the leg or legs of the
trip on which passengers are aboard.25 In other words, if
JULY-AUGUST 2005
an executive were to fly alone on the company aircraft for
a four-hour flight, the total number of occupied seat hours
attributable to his trip will be eight, if the aircraft returns
to the origination point with no passengers. This is the
result, regardless of whether the executive’s trip was for
business or personal/entertainment reasons.
The Notice, however, offers no examples explaining the
operation of the deadhead rule when the facts are more
complicated than the situation where the aircraft makes
a roundtrip with respect to the specified individual’s trip.
Consequently, it is not clear how the deadhead trip is
treated, if the aircraft flies to a different destination after
dropping off the executive. For example, if the aircraft flies
an executive from Dallas to Aspen for personal purposes,
then flies to Seattle without passengers to pick up a business traveler before returning to Dallas, the Notice does
not tell the taxpayer how the segment of the trip without
passengers should be allocated to the other segments that
are both business and personal.
H. Allocation Rule for Trips with Both Business
and Personal Segments — Incremental
Approach Redux
Interestingly, even though the Notice generally rejects
an incremental approach to determining the allocation of
costs, the Notice does retain such an approach to allocation
of costs when a trip includes both business and personal
segments. The Notice directs the taxpayer to compare the
costs of the total flights taken (based on occupied seat hours
or miles) to the cost of the flights that would have been taken
(again looking to the number of occupied seat hours or miles)
without the entertainment segment or segments. The costs
attributable to the excess occupied seat hours or miles is
the amount disallowed, less any amounts treated as compensation or reimbursed by the specified individual to the
taxpayer. This comparison approach is similar to the rule
available for determining the value of the personal portion of
a trip under the SIFL rules of Treas. Reg. § 1.61-21(g)(4)(ii)
when the trip is primarily for business purposes.
I.
Relief from the Consistency Rule when
Applying the SIFL Rules
The Notice permits taxpayers who have elected to value
their employees’ personal flights using the SIFL rules to
value the entertainment use of the aircraft by specified
individuals using general valuation principles,26 without
violating the requirement to use only the special valuation rules once elected. In other words, the consistency
requirement of the noncommercial flight valuation rule27
(requiring a taxpayer electing to use the SIFL rules must
use those rules to value all flights provided to employees
during the year) will not be violated if the taxpayer values
the entertainment use of the aircraft by specified individuals
under fair market value, but continues to value flights for
other employees and for specified individuals not traveling
for entertainment using the SIFL formula.
This relief from the consistency requirement effectively
permits companies to minimize the effect of the deduction
disallowance by applying fair market valuation to determine
the amount to be treated and reported as compensation paid
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Notice 2005-45: The IRS Takes Aim at Executives’ Entertainment Use of Company Aircraft
to the specified individual or the amount that the specified
individual may reimburse. Companies should be careful,
however, of the potential collateral complications the use of
this rule could create, as revealed in the Notice’s warning
that “[i]f the amount treated as compensation is greater
than the amount of the taxpayer’s costs (as determined
under this notice ) for a flight, the taxpayer’s deduction is
limited to the taxpayer’s costs.”
Specifically, the choice permitted by the Notice appears
to be limited to calculating the specified individual’s compensation using either the SIFL rules or general valuation
principles, but not an amount in between the two that would
equal or approximate costs allocated to the entertainment
use under the Notice’s methodology. In other words, the
company would not be permitted to include in the specified individual’s compensation an amount equivalent to the
company’s costs in any situation where the fair market value
exceeds those costs. The result for taxpayers is a “lose/lose”
situation, because they are limited to a deduction based on
costs if the value imputed (or reimbursed) is greater than
the costs of maintaining and operating the aircraft, and
limited to value if the costs of operating the aircraft are
greater than the value imputed to specified individuals or
reimbursed by them using either the SIFL valuation method
or charter value.
III. The Collateral Effects Caused By the Changes to
Section 274(e)(2) and the Pro Rata Allocation
Method of Notice 2005-45
A. Depreciation Puzzle
It is unclear whether the IRS intended to modify the
mechanical rules related to the depreciation of aircraft
through the issuance of Notice 2005-45,28 but the Notice
leaves in its wake a number of unanswered questions in
this area. Paramount is whether the statutory changes to
sections 274(e)(2) and (9) also indirectly reduce the percentage of business/investment use of a taxpayer’s aircraft for
depreciation purposes, and reduce the amount of aircraft
depreciation that can be taken, even before the application of the disallowance rules described in Notice 2005-45.
This issue arises because the computation of depreciation
in Treas. Reg. § 1.280F-6(d)(3)(ii) is predicated upon the
treatment of related entertainment expenditures under
section 274.29
The IRS should address whether the method for allocating expenses (occupied seat hours or occupied seat miles)
is now the method for determining the business use percentage of an aircraft. Before enactment of AJCA and the
issuance of Notice 2005-45, it was likely that most corporate
aircraft qualified for 100-percent business use because even
when used in connection with entertainment, the aircraft
was considered a means of compensating employees, which
itself qualified as a business use.30 It is no longer clear
whether this approach continues to apply if the compensatory use by the employee results in some disallowance of
depreciation under section 274 and the new rules in Notice
2005-45. Until this issue is addressed, taxpayers should
avoid having the business use of an aircraft drop to the level
of 50 percent or below under the Notice’s expense allocation
method for any depreciable year because such a drop could
352
require the recapture of all previous accelerated depreciation in excess of the straight-line amount.31
Another area of uncertainty is the calculation and
treatment of gain (recapture) or loss on a subsequent disposition of an aircraft for which depreciation deductions
were previously disallowed. This issue arises because the
methodologies for determining nondeductible depreciation
under the Notice and ultimately the gain or loss on a disposition do not fit neatly within the existing statutory and
regulatory framework, in that the amount of depreciation
disallowance under the Notice results at least in part from
a failure to impute sufficient income to “specified individuals,” which does not easily translate into a nonbusiness
use percentage.
If the IRS concludes that taxpayers should continue to
compute depreciation deductions on corporate aircraft as
though the entire use of the asset is business use,32 there
remains the issue of how taxpayers will compute gain or
loss on a subsequent disposition of the aircraft given Treas.
Reg. § 1.274-7.33 While Treas. Reg. § 1.274-7 seems to
preserve basis for the taxpayer, it is unclear what “portion”
of an aircraft would be treated as personal use. It will be
important in this instance for the IRS to provide guidance
that will harmonize the section 274 rules with the section
280F rules, rather than leave taxpayers to guess at the
proper result.
B. “Heads, the IRS Wins; Tails, the Taxpayer
Loses”— The Interaction with Section 162(m)
Any amount for the entertainment use of an aircraft
that is treated as compensation to a specified individual
who is also a “covered employee” is subject to the deduction
disallowance of section 162(m) of the Code. Thus, to the
extent the covered employee’s “applicable employee remuneration” for section 162(m) purposes exceeds $1 million,
the taxpayer’s deduction is disallowed under section 162(m).
The Notice thereby blurs the conceptual distinction between
deductions based on aircraft cost and employee income based
on the value of aircraft use, by applying the compensation
deduction disallowance rules of section 162(m) to amounts
that are treated as compensation because of entertainment
use of corporate aircraft, even though corporate deductions
are otherwise based on the cost of the aircraft, rather than
the value imputed to the employee.
C. Double Hammer when Entertainment Flights
Are Mischaracterized as Business Flights
Given the effect of the new deduction disallowance rules
on any entertainment use of their aircraft, companies might
be tempted to be aggressive in characterizing aircraft use
by specified individuals as business use, instead of personal or entertainment use. Companies should be aware
of the consequences of being wrong in such instances. If a
company takes the position that a flight by a specified individual is a business flight and therefore it does not apply
the deduction disallowance rules of new section 274(e)(2)
to the expenses, and the IRS subsequently challenges the
company’s treatment of the flight as business, there could be
both a retroactive payroll tax assessment based on charter
value (for failing to treat the flight as a taxable benefit) and
THE TAX EXECUTIVE
Notice 2005-45: The IRS Takes Aim at Executives’ Entertainment Use of Company Aircraft
a deduction disallowance with respect to the expenses.
The SIFL valuation rule of Treas. Reg. § 1.61-21(g)
is a “special valuation rule” that may only be used if the
employer and employee meet the requirements of Treas.
Reg. §§ 1.61-21(c)(2)(ii) and 1.61-21(c)(3)(ii). Where the
IRS takes the position that a flight provided to a “control
employee” (a definition that will overlap with the definition of a “specified individual” in most cases) was wrongly
characterized as business, the IRS is not required to base
its retroactive payroll tax assessment on the value determined under SIFL rules if certain conditions have not been
met. This is because neither the employer nor the control
employee may use a special valuation rule unless one of
the following is true:
•
the employer treated the value of the benefit as
wages for reporting purposes within the time for
filing the returns for the taxable year (including
extensions) in which the benefit is provided;
•
the employee included the value of the benefit in
income within the time for filing the returns for
the taxable year (including extensions) in which
the benefit is provided: or
•
the employer demonstrates a good faith effort to
treat the benefit correctly for reporting purposes.
Assuming that the prescribed time for filing the
returns has elapsed by the time the IRS challenges the
treatment of the flight as a business flight, the regulations
permit the IRS to apply fair market valuation (i.e., the
charter rate) for purposes of assessing the payroll taxes
thereon. Moreover, Treas. Reg. § 1.274-2(f)(2)(iii)(A) applies a “double hammer”; the employer, in addition to being
assessed payroll taxes based on charter valuation, will not
be permitted to deduct expenses incurred in connection
with the use of the entertainment facility, because the
benefit was not treated as compensation on the company’s
income tax return as originally filed and was not treated
as wages for income tax withholding purposes. It is not
entirely clear how this total deduction disallowance rule
in the existing regulations interacts with the partial deduction disallowance rule of section 274(e)(2) of the Code,
which would ordinarily permit a portion of the deduction
equal to the amount included in the specified individual’s
compensation. In other words, if the employer mischaracterizes a flight as business and the IRS recharacterizes
the flight as entertainment for payroll tax purposes, it
is possible that the employer may not get “credit” for
the amount retroactively treated as compensation when
it calculates the deduction disallowance attributable to
the recharacterized entertainment flight. Optimally, this
will be clarified when the IRS issues regulations under
amended section 274(e)(2).
D. “Come Fly with Me” — Treatment of Spousal
Travel
It is not clear how the deduction disallowance rules
under section 274(m)(3) of the Code pertaining to spousal
and guest travel34 interface with amended section 274(e)(2).
JULY-AUGUST 2005
The regulations under section 132(d) provide that the disallowance under section 274(m)(3) for the taxpayer’s provision
of spousal travel expenses does not preclude those amounts
from qualifying as an excludable working condition fringe
benefit to the extent that:
(i)
the employer has not treated such amounts as
compensation under section 274(e)(2);
(ii) the amounts, if incurred by the employee, would
be deductible by the employee under section 162(a)
(without regard to section 274(m)(3));
(iii) it can be adequately shown that the spouse’s presence on the employee’s business trip has a bona
fide business purpose; and
(iv) the employee substantiates the travel within the
meaning of Treas. Reg. § 1.132-5(c).35
Therefore, assuming the spouse’s presence on the trip
is for bona fide business purposes, the employer may effectively choose who should bear the tax burden of the section
274(m)(3) deduction disallowance. For any travel expenses
that are business-related, the employer can deduct such
amounts as compensation if the employer chooses to include
the “amount paid or incurred” for the employer-provided
spousal travel in the employee’s income. Alternatively, if the
employer chooses to absorb the section 274(m)(3) deduction
disallowance, it can exclude from the employee’s income, as
a working condition fringe benefit, any reimbursements or
payments for spousal travel that has a bona fide business
purpose. Ideally, the proposed regulations will confirm
that the reference to section 274(e)(2) in Treas. Reg. § 1.1325(t)(1) does not mean that the disallowance rules of section
274(e)(2) (as opposed to section 274(m)(3)) would apply in
any situation in which the spouse or guest is flying for bona
fide business reasons, even if he or she is deemed to be a
specified individual by virtue of his or her relationship to the
service provider, because entertainment is not involved.
The treatment of spousal travel expenses and the interaction with the new rules for specified individuals in section
274(e)(2) becomes more confusing in the case of spousal travel
expenses that are not for bona fide business purposes (and
therefore the basic test for a “working condition exclusion”
under Treas. Reg. § 1.132-5(t)(1) has not been met). In such
a circumstance, the employer may not utilize the election
procedure described above (i.e., it cannot elect to exclude the
cost of the trip from the employee’s income, in exchange for
forgoing the tax deduction). The regulations provide that “the
value of the employer’s payment of travel expenses” must be
included in the service provider’s income. This language appears to base inclusion on incremental costs rather than on
the value of the spousal travel, even though most employers
value personal flights on company aircraft using the SIFL
valuation rules.36 In the case of spousal travel provided
to a specified individual who is not for bona fide business
purposes (i.e., the purpose of the travel is considered to be
the entertainment of the spouse), the proposed regulations
should clarify which deduction disallowance rules — section 274(m)(3) or 274(e)(2) — when the benefit is treated as
compensation. If the disallowance rules of section 274(e)(2)
apply, the company will apparently be subject to a deduction
353
Notice 2005-45: The IRS Takes Aim at Executives’ Entertainment Use of Company Aircraft
disallowance under section 274(e)(2) in the amount by which
the costs allocated under the Notice’s methodology exceed the
incremental costs included in income.
E.
Avoiding an Excise Tax Complication and an
FAA Trap
The Notice permits companies to determine the specified individual’s compensation related to entertainment use
of the aircraft based on fair market value, which reduces the
amount of the deduction disallowance. Although reimbursement sounds like a good idea for reducing the amount of
the deduction disallowance, the Notice does not mention the
complications that can arise in complying with the excise tax
and Federal Aviation Administration rules if the taxpayer
accepts reimbursements from specified individuals.
First, section 4261(a) of the Code imposes an excise
tax on amounts paid for air transportation and that tax
can be triggered when an employee reimburses his employer for a flight. For 2005, the tax is 7.5 percent of the
fare paid plus $3.20 per domestic flight segment. Thus,
if a specified individual were to reimburse the company
for a personal/entertainment flight, the excise tax under
section 4261(a) would apply to the amount paid by him or
her for air transportation. If the value of the flight is only
imputed to the specified individual, however, the excise tax
does not apply because no amount has been paid for the
transportation.37
Second, entities operating aircrafts under Part 91 of
Federal Aviation regulations38 are not subject to the more
stringent safety and certification requirements that apply
to commercial operators responsible for transporting the
public. Consequently, there are rules limiting the extent to
which operators under Part 91 may charge passengers for
air transportation (including employees of the entity that
owns the aircraft). Federal Aviation regulations do permit
“time-share” agreements,39 but the maximum amount that
can be charged under such an agreement is strictly limited
under the regulations, to two times the gasoline, plus a
few additional incremental costs.40 Consequently, any reimbursement under a time-share agreement will not equal
the charter value, so that such reimbursement is unlikely
to insulate the company from the impact of the new deduction disallowance rules in section 274(e)(2) in the case of
specified individuals.41
F.
Waiting for the Other Shoe to Drop — SEC
Reporting
Although officials of the Securities and Exchange
Commission have acknowledged that the proxy reporting
rules pertaining to executive compensation are in need of
revision, the project is apparently only in its early stages.
Based on informal conversations with SEC staff, it does not
appear that the tax costs of the lost deduction for personal
flights by specified individuals would be considered part of
the “aggregate incremental costs” of providing “perquisites
and other personal benefits” that must be reported in the
Summary Compensation Table if the incremental costs of
a top executive’s non-cash fringe benefits exceed the lesser
of either 10 percent of his or her total salary or $50,000.42
In light of the attention that executive fringe benefits have
354
received in recent years, however, corporations would be
well served to pay close attention to SEC guidance and
enforcement actions and to consult securities counsel on
this subject.
IV. Effective Date and Transition Rules
Section 274(e)(2) applies to expenses incurred after
October 22, 2004. The pro rata allocation method of Notice 2005-45 applies to expenses incurred after June 30,
2005. The Service will not challenge a reasonable method
of determining disallowed expenses incurred after Oct. 22,
2004, and before July 1, 2005. Application of the Notice to
determine disallowed expenses is deemed to be a reasonable method.
Taxpayers with a taxable year ending after October
22, 2004 (the date of AJCA’s enactment) and on or before
May 27, 2005 (the date of the Notice) may apply the disallowance of expenses for that (earlier) taxable year against
expenses incurred in the first taxable year ending after
May 27, 2005. Thus, a calendar-year taxpayer may choose
to adjust its taxable income either (a) for its 2005 taxable
year to reflect the disallowance of expenses incurred after
October 22, 2004, and before January 1, 2006, or (b) for its
2004 taxable year to reflect the disallowance of the portion
of the expenses incurred after October 22, 2004, and before
January 1, 2005, and for its 2005 taxable year to reflect the
disallowance of the portion of the expenses incurred after
December 31, 2004, and before January 1, 2006.
If the taxpayer chooses to include the post-October 22
disallowance of expenses in its 2005 year, it is possible that
it would be considered “a reasonable method” if the taxpayer
simply performs one deduction disallowance calculation including the expenses for the last 10 weeks of 2004 with the
expenses for 2005, rather than separate calculations for the
last 10 weeks of 2004 and 2005.
V.
Conclusion
The new deduction disallowance rules reflected in Notice 2005-45 go well beyond simply reversing the outcome
in the Sutherland case. They are broad in scope and, from
the taxpayer’s perspective, harsh in their application. In
particular, the expense allocation method set forth in the
Notice, which is used for attributing aircraft operating expenses to entertainment use, has the effect of penalizing any
entertainment use of the aircraft by a specified individual,
regardless of who else is on the particular flight and the
business reasons necessitating that flight. The Notice may
be viewed as an attempt by the IRS, not just to implement
the statutory changes made by the AJCA to section 274,
but to change corporate behavior in general with regard to
entertainment use of corporate aircraft by executives.
1
114 T.C. 197 (2000), aff’d, 255 F.3d 495 (8th Cir. 2001), acq. AOD
2002-02 (Feb. 11, 2002). See also Midland Financial Co. v. Commissioner, T.C. Memo. 2001-203; National Bancorp of Alaska, Inc.
v. Commissioner, T.C. Memo. 2001-201; and Chief Counsel Advice
200344008 (October 31, 2003) (applying Sutherland, IRS allowed
S corporation’s deductions for personal use of corporate aircraft by
THE TAX EXECUTIVE
Notice 2005-45: The IRS Takes Aim at Executives’ Entertainment Use of Company Aircraft
shareholders and employees that made up 95 percent of aircraft’s
use, where value of each flight was included in income using the
special valuation rules applicable to flights on noncommercial
aircraft).
2
2005-24 I.R.B. 1228 (June 13, 2005).
3
American Jobs Creation Act of 2004, Pub. L. No. 108-357, § 907(a),
118 Stat. 1418, 1654-55.
4
Section 274(e)(2) previously provided that section 274(a) did
not apply to “[e]xpenses for goods, services, and facilities, to the
extent that the expenses are treated by the taxpayer, with respect
to the recipient of the entertainment, amusement, or recreation,
as compensation to an employee on the taxpayer’s return of tax
under this chapter and as wages to such employee for purposes
of chapter 24 (relating to withholding of income tax at source on
wages).” (Emphasis added.) The Tax Court observed in Sutherland
that, had Congress intended to limit the taxpayer’s deduction to
the amount included in the employee’s compensation as opposed
to providing an exception, it knew how to use language like “to the
extent of.” 114 T.C. at 205.
5
The provision amending section 274(e)(2) also includes a crossreference to section 274(e)(9), which pertains to non-employees; the
same deduction disallowance occurs with respect to entertainment
flights provided to independent contractors who happen to be specified individuals. I.R.C. § 274(e)(2)(B)(i).
6
See I.R.C. § 274(e)(2)(A).
7
H.R. Rep. No. 108-755, 108 Cong., 2d Sess. 784 (2004) (Conference Report).
8
A mismatch between the value imputed in compensation and the
employer’s deduction for the expense of providing the benefit also
occurs to a lesser degree in the case of company cars, when the
employer uses the special valuation rules of Treas. Reg. §§ 1.6121(d) (automobile lease valuation rule), (e) (vehicle-cents-per-mile
rules), and (f) (commuting valuation rule) to value the employee’s
personal use.
9
The use of the SIFL rules to value executives’ personal use of aircraft was the result of a compromise between congressional leaders
and the Treasury’s Office of Tax Policy, during the debate over the
repeal of the contemporaneous recordkeeping requirements added
by the Tax Reform Act of 1984. Pub. L. 99-44 (1985), reprinted
at 1985-2 C.B. 350. The congressional record makes it clear that
Senate leaders were aware of the mismatch. See 131 Cong. Rec.
S6367 - S6371 (daily ed. May 16, 1985).
10
Treas. Reg. § 1.61-21(b)(2) (1989); Temp. Reg. § 1.61-2T(b)(2)
(1985).
Section 162 allows a deduction for ordinary and necessary business expenses, including compensation paid for personal services.
When the compensation is paid in form of a noncash fringe benefit,
Temp. Reg. § 1.162-25T provides that the employer may deduct its
cost to provide the benefit if the value of the benefit is included
in the employee’s gross income. In measuring the amount of the
deduction, however, the employer is precluded from deducting the
amount included in the employee’s compensation.
11
12
Temp. Reg. § 1.162-25T.
13
H.R. Rep. No. 108-755, at 784.
14
The noncommercial flight valuation rule of Treas. Reg. § 1.6121(g)(12) provides a special valuation rule if at least half the
“regular seating capacity” of the aircraft is filled with business
travelers (i.e., service providers for the company who could exclude
their flights as working condition fringe benefits) at the time the
individual whose personal flight is being valued both boards and
deplanes. If this test is met, current and retired employees or
partners of the employer and their spouses and dependent children
may fly in the remaining seats for free.
15
To the extent, the express purpose of the amendment was to
JULY-AUGUST 2005
overturn the decision in Sutherland, it is instructive to look at how
expenses were allocated in that case. There, the taxpayer and the
government had stipulated to the expenses allocated to the vacation flights and had determined those expenses by apportioning
the flight miles that the plane flew, without apparent regard to the
number of passengers on the plane for any given trip.
16
The taxpayer may choose either occupied seat hours or occupied seat miles for this purpose, but must use the chosen method
consistently for all usage for the taxable year. Moreover, the cost
per occupied seat hour or mile may be calculated for each aircraft
or aircraft with “similar cost profiles” may be aggregated. Other
than the examples in the Notice that neither turboprop aircraft
and jet aircraft, nor two-engine jet aircraft and four-engine jet
aircraft may be aggregated, though, the Notice does not provide
any commercial or regulatory reference that would shed light on
the interpretation of what is a similar cost profile.
17
Pursuant to Treas. Reg. § 1.132-5(m), a working condition fringe
exclusion applies to the value of a personal flight provided to an
executive covered by an independent security study (because of
a bona fide business-oriented security concern) in excess of 200
percent of the SIFL rate. The Notice’s application to such flights
results in a greater deduction disallowance under section 274(e)(2),
if the lower SIFL valuation is included in the protected executive’s
income rather than fair market value.
18
See also Rev. Rul. 63-144, 1963-2 C.B. 129, Q&A 10. The Notice
arguably modifies the regulations’ reference to commuting use of an
autmobile by adding the word “use,” which potentially distinguishes
commuting use as a form of entertainment use.
19
In contrast, Q & A 11 of Rev. Rul. 63-144 observes that vacation
use of an automobile constitutes entertainment.
20
See Treas. Reg. § 1.132-5(a)(2)(ii) (flights provided to employee
in conjunction with serving on the board of an unrelated company
doing business with the employer or on the board of a charity
treated as working condition fringe benefits).
21
Curiously, the Notice does not address whether entertainment
flights provided to a former service provider, who would have been
a specified individual when he or she performed services (e.g., a
former officer or a director), are subject to the new deduction disallowance rules. This is surprising in light of the fact that the
fringe benefit rules were careful to provide that for purposes of
valuing personal flights, retirees who became “control employees”
after reaching age 55, or within three years before their retirement, must always be treated as control employees, which means
that higher SIFL values will apply to their personal trips. Treas.
Reg. § 1.61-21(g)(11). The linkage to section 16(a), however, may
demand a different result. In addition, the Notice does not address
how to treat flights provided to individuals who are less than two
years old. For fringe benefits purposes, the value of their flights
is deemed to be zero. Treas. Reg. § 1.61-21(g)(1).
22
Treas. Reg. § 1.61-21(b)(5) states that “[t]he ‘provider’ of a fringe
benefit is that person for whom the services are performed, regardless of whether that person actually provides the fringe benefit to
the recipient.” Thus, under certain situations, the common law
employer is treated as the provider of the noncash benefit for payroll tax purposes, even though a third party actually furnishes
the benefit.
23
The issues associated with the determination of “specified individuals” would have been rendered moot if a proposal passed
by the Senate in May 2005 had been enacted. Under in the Senate version of the 2005 Highway Bill, the disallowance would be
extended to expenses for all persons using the facility or benefit
for entertainment purposes. Safe, Accountable, Flexible, and Efficient Transportation Equity Act of 2005 (Engrossed Amendment
as Agreed to by Senate), H.R. 3, 109th Cong., § 5516 (2005). The
provision, however, was not included in the final legislation, though
it might be reintroduced at a later time.
24
See I.R.C. § 274(f); see also Rev. Rul. 63-144, Q&A 49.
25
Deadhead flights attributable to personal flights are not valued
355
Notice 2005-45: The IRS Takes Aim at Executives’ Entertainment Use of Company Aircraft
for income inclusion purposes under Treas. Reg. § 1.61-21(g). Also,
the Notice’s definition of deadhead flights leaves open questions
about the treatment of maintenance flights for purposes of the
allocation rule.
26
See Treas. Reg. § 1.61-21(b)(6) (fair market value of employerprovided piloted flight is equal to the amount that an individual
would have to pay in an arm’s-length transaction to charter the
same or a comparable piloted aircraft for that period for the same
or comparable flight).
27
Treas. Reg. § 1.61-21(g)(14)(i).
28
Sections 167 and 168 combine to provide for the depreciation
of assets used in a trade or business or held for the production of
income. Section 280F limits accelerated depreciation for assets
considered “listed property.” Aircraft that is not used substantially
in a trade or business for the transportation of goods or property
is listed property. I.R.C. § 280F(d)(4)(C). Only the business use of
such aircraft is depreciable. Listed property that is used 50 percent
or less for business use may not be depreciated using an accelerated depreciation method. Further, taxpayers must recapture all
previously claimed excess depreciation and 179 deductions claimed
on listed property over the straight-line amount if the business use
percentage falls to 50 percent or below and utilize the straight-line
depreciation method thereafter. Temp. Reg. § 1.280F-3T(c).
29
Treas. Reg. § 1.274F-6(d)(3)(ii) provides that listed property used
for entertainment, recreation, or amusement purposes is treated as
business use “to the extent that expenses (other than interest and
property tax) attributable to that use are deductible after application of section 274.” Stated differently, if the expenses for the use
of an aircraft are deductible by the taxpayer and not disallowed by
section 274, the use of the aircraft is treated as business use.
30
See Temp. Reg. § 1.162-25T; CCA 200344008 (July 1, 2003).
31
See Temp. Reg. § 1.280F-3T(c).
32
See CCA 200344008 (July 1, 2003).
33
Treas. Reg. § 1.274-7 states, “If deductions are disallowed under
§1.274-2 with respect to any portion of a facility, such portion shall
be treated as an asset which is used for personal, living, and family
purposes (and not as an asset used in trade or business). Thus, the
basis of such a facility will be adjusted for purposes of computing
depreciation deductions and determining gain or loss on the sale of
such facility in the same manner as other property (for example, a
residence) which is regarded as used partly for business and partly
for personal purposes.”
34
This disallowance for spousal travel applies to 100 percent of the
travel expenses incurred. Travel expenses include cost of transportation, lodging and meals while away from home overnight, and
expenses incidental to travel. Treas. Reg. § 1.162-2(a).
35
Treas. Reg. § 1.132-5(t)(1).
36
The IRS has never specifically addressed in conjunction with
spousal travel what amounts should be disallowed if working condition fringe benefit treatment is elected, or what amounts should be
included in wages or deducted if compensation treatment is elected.
The language of Treas. Reg. § 1.132-5(t)(1) suggests an incremental
approach, that is to say, the additional cost of a second person in the
hotel room or to accompany the employee on the company aircraft
or in the company car, which is traveling for business purposes.
See also Rev. Rul. 56-158, 1956-1 C.B. 94; Marlin v. Commissioner,
54 T.C. 560 (1970).
37
See Rev. Rul. 72-245, 1972-1 C.B. 347, and Private Letter Ruling
9028027 (April 5, 1990).
38
14 C.F.R. § 91, et.seq.
39
14 C.F.R. § 91.501(c)(1).
40
14 C.F.R. § 91.501(d).
41
Of course, any amounts reimbursed under a time-share arrangement would be subject to the excise tax under section 4261(a) of
the Code.
42
See Instructions to 17 C.F.R. § 229.402(b)(2)(iii)(C).
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William S. Hein & Co., Inc. • 1285 Main Street, Buffalo, NY 14209 • 800.828.7571(p) • 716.883.8100 (f)
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THE TAX EXECUTIVE