Avoiding Tax Pitfalls of Aircraft Ownership in an S Corporation

The S Corporation is becoming the business entity of choice, especially among small to medium-sized owners. Some of the reasons to choose an S Corporation for business structure include tax efficiency, operational simplicity, and ease of ownership. However, owning an aircraft for an S Corporation may leave you and your tax savings grounded.

Basis limitations

It is not easy for business owners to deduct losses as the tax codes are complicated. This is true, especially for S Corporation owners. From basis limitations to the recent addition of the excess business loss limitation rules, claiming losses on your return is more challenging. The benefit of aircraft ownership in a business structure is the resulting loss you generate by taking first-year bonus depreciation or the Section 179 deduction. Your business write-off of an aircraft in the first year of ownership creates an immediate tax benefit, significantly if you leverage debt to finance your aircraft’s purchase.

Not So Fast

Those tax savings may be limited if you purchase that aircraft through an S Corporation. Generally, you can claim losses only to the extent of your basis in your stock and any shareholder loans to your S Corporation. Unlike in a partnership entity structure, debts of the S corporation to a third-party lender will generally not give you the basis you need to claim significant losses.

Important point: If you use an S corporation to own an airplane, ensure you have the necessary basis to deduct the losses you want.

Tax planning tip 1: Avoid debt financing the purchase of an aircraft by an S Corporation. Use cash instead.

Tax planning tip 2: If the S corporation needs more cash, it can take out a personal loan and lend the proceeds to the S Corporation before purchasing the aircraft.

Depreciation Recapture

Generally, the tax code gives you two methods for depreciating an aircraft: the modified accelerated cost recovery system (MACRS) and the alternative depreciation system (ADS). The aircraft used predominantly in a business will be depreciated under MACRS, while an airplane failing that 50 per cent test will be subject to ADS.

For significant deductions up front, you need more than 50 per cent business use of your airplane to claim bonus depreciation. If you fail the 50 per cent business use test, you must use the distasteful ADS, which means straight-line depreciation over a six-year or twelve-year recovery period.

To retain the original significant deductions, you must hold your business use above 50 per cent because the tax code deems airplanes “listed property”, a classification that triggers special depreciation recapture rules.

It does not mean that you never let your business use of the aircraft fall to less than 50 percent. Aircraft depreciation recapture is often misunderstood as a recapture of all prior-year depreciation. When the business use falls less than 50 per cent, the corporation recaptures only the excess MACRs depreciation over ADS. If the aircraft is fully depreciated under ADS, your S Corporation has no excess depreciation to recapture.

If you want to take the airplane out of S Corporation, you can do it as it is not yours but the S Corporation’s. If you wish the S Corporation to give the aircraft for your use, then it has to treat it as a distribution, or you have to buy it at fair market value. And this sale by the S corporation to you or any other person triggers depreciation recapture subject to tax at ordinary income tax rates.

Tax planning tip 1: If you eventually want to own the aircraft personally donot use an S-corporation

Tax planning tip 2: If you still want the aircraft, wait until the fair market value has dropped to levels that can absorb the taxable income hit.

Cost sharing arrangements: The aircraft ownership cost is high; the business owners may share the cost with others. For those with multiple owners in the business, you might want to allocate the aircraft cost based on the owner’s usage. The S corporation does not offer the ability to allocate aircraft expenses to the owner based on use. The S corporation must allocate tax items pro rata based on the shareholder’s ownership. That makes the S corporation a lousy entity for cost-sharing arrangements.

Tax planning tip 1: Use a partnership structure

Takeaways: Choosing an S corporation as your business entity offers many advantages, like tax efficiency and operational simplicity. When it comes to aircraft ownership, the disadvantages negate the advantages. The three major issues are:

Basis Limitations
Depreciation recapture
Cost sharing arrangements