By John B. Hoover, Esq.
Dow Lohnes PLLC, Washington, DC
Two items of recent IRS guidance have inadvertently created an extraordinary tax-saving opportunity for companies that acquired new business aircraft between September 8, 2010, and December 31, 2012.
As background, 100% bonus depreciation for business aircraft became available for new aircraft purchased after September 8, 2010, and before January 1, 2012, except that a new business aircraft purchased during 2012 can also qualify if it was purchased pursuant to a written binding contract in place prior to January 1, 2012. In addition, if a business aircraft is used for entertainment travel (e.g., vacations), then the percentage of flights for the year that are for entertainment is multiplied by the aircraft operating costs, including depreciation, for the year to calculate the amount of aircraft expense that is nondeductible under the entertainment disallowance.
Notwithstanding these two rules, recent IRS guidance allows companies (a) to deduct 100% bonus depreciation for business aircraft placed in service in 2012, even if there was no written binding contract in place as of January 1, 2012, and (b) to make a special straight-line depreciation election solely for purposes of the entertainment disallowance, which almost eliminates the entertainment disallowance with respect to depreciation expense.
With regard to 100% bonus depreciation, Rev. Proc. 2011-26, §3.02(1)(a) effectively eliminated the requirement to have a written binding contract on January 1, 2012, to claim 100% bonus depreciation on business aircraft acquired during 2012. Based on informal statements by IRS staff, this relaxation of the written binding contract requirement was intended. In addition, it is consistent with the relaxation of the written binding contract rule on September 8, 2010, when 100% bonus depreciation was first available. Accordingly, it appears to be the case that this revenue procedure eliminates the written binding contract requirement for business aircraft purchased during 2012 to be eligible for 100% bonus depreciation.
With regard to the entertainment disallowance, Regs. §1.274-10(d)(3) of the final entertainment regulations issued August 1, 2012, provides that a company may elect to use the straight-line depreciation method solely for purposes of the entertainment disallowance. Under this election, the company deducts its otherwise allowable regular depreciation, such as bonus or MACRS depreciation, but only the straight-line depreciation expense is included in the aircraft operating costs that are multiplied by the entertainment flight percentage to calculate the entertainment disallowance. In addition, the final regulations added a provision that was not in the proposed regulations. The final regulations limit the amount of the disallowance of depreciation calculated under the straight-line method to the amount of regular (i.e., bonus or accelerated) depreciation for the year. Based on informal conversations with IRS staff, it appears that the extraordinary tax-savings created by this cap for companies claiming bonus depreciation and making the election was not anticipated by the IRS. Nevertheless, the IRS staff agree that this is the correct result.
Putting these two rules together provides an extraordinary tax-saving opportunity as follows: Suppose a company bought a new aircraft in 2012 and uses it to a substantial extent for entertainment travel in 2012 as well as in future years. Under Rev. Proc. 2011-26, the company could qualify to deduct 100% bonus depreciation on the new aircraft, even though the company may not have entered into a written binding contract to acquire the aircraft before 100% bonus depreciation otherwise expired on December 31, 2011. Under Regs. § 1.274-10(d)(3), the company can elect straight-line depreciation solely for purposes of calculating its entertainment disallowance. If the straight-line election is made, the depreciation on the aircraft in 2012 solely for purposes of the entertainment disallowance calculation would be 1/12th of the cost of the aircraft (based on a six year alternative depreciation system life, and a half-year convention). This means that even though the company deducts 100% of the purchase price of the aircraft in the year of acquisition (2012), the entertainment disallowance is calculated by multiplying the percentage of entertainment flights by 1/12th of the cost of the aircraft. This rule results in a minimal entertainment disallowance with respect to depreciation in the year of acquisition.
In subsequent years, the depreciation calculated under the straight-line method is subject to the entertainment disallowance calculation. However, a sentence inserted in Regs. § 1.274-10(d)(3)(i), caps the amount of the entertainment disallowance of straight-line depreciation at the amount of the regular depreciation (i.e. bonus or accelerated). When bonus depreciation is claimed in the year of acquisition, the regular depreciation in every subsequent year is zero. Therefore, the depreciation disallowance in such subsequent years calculated using the straight-line method is likewise capped at zero. As a result, only 1/12th of the total depreciation is subject to the entertainment disallowance in the year of acquisition and in subsequent years, none of the depreciation is disallowed.
In addition to providing an extraordinary tax-saving opportunity for new business aircraft purchased in 2012, taxpayers who claimed bonus depreciation on new aircraft acquired in 2011 or after September 8, 2010, may be able to benefit from this tax-saving opportunity by amending their 2011 or 2010 returns to elect the straight-line method for entertainment disallowance purposes.
The above discussion of these rules oversimplifies them. There are many complexities and risks in applying these rules that are not mentioned above, and companies should consult their tax advisors before making the elections discussed herein.
For more information, in the Tax Management Portfolios, see Stechel, 519 T.M., Travel and Transportation Expenses - Deduction and Recordkeeping Requirements, Stechel, 520 T.M., Entertainment, Meals, Gifts and Lodging - Deduction and Recordkeeping Requirements, and Maule, 532 T.M., First-Year Expensing and Additional Depreciation and in Tax Practice Series, see ¶2310, Travel and Transportation Expenses, and ¶2320, Entertainment Expenses.
© 2013 John B. Hoover, Esquire
Copyright©2013 by The Bureau of National Affairs, Inc.
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