Income tax benefits are generally unaffected when an aircraft purchaser is deciding whether to finance or buy an aircraft with cash. Available depreciation schedules (including bonus depreciation and other forms of accelerated depreciation) are not affected and are available in both financed and cash acquisitions.
However, there are a few key areas in which tax planning and aircraft financing intersect. One key area is the aircraft’s optimal (or required) ownership structure.
Some lenders require that an individual taxpayer owns the aircraft ownership LLC rather than an operating company or other business entity. Even if the taxpayer’s entities are “passthrough entities” flowing to the taxpayer’s Form 1040, this ownership structure can be problematic from an income tax reporting perspective.
In this situation, the taxpayer may be prohibited from taking accelerated depreciation because they used a related party leasing structure. An IRS audit could also challenge the aircraft's deductibility because the aircraft is reported on a standalone basis (separate from the applicable operating company or companies). In addition, this standalone reporting may create a poor optic on the taxpayer’s Form 1040 by creating a large loss on their Schedule C or Schedule E, drawing substantial attention to their tax return. Aviation tax advisors often steer their clients away from these ownership structures in favor of parent/subsidiary structures with the aircraft ownership LLC wholly owned by an operating company.
Another key area where aircraft financing and aviation tax planning overlap is basis generation when the aircraft deductions are reported on a Form 1120-S (S-Corporation tax return). In this instance, a personal guarantee from the individual taxpayer is not enough to create debt basis for the individual taxpayer in the S-Corporation if the loan structure features the S-Corporation or a wholly owned subsidiary of the S-Corporation as the borrower.
Aviation tax advisors often propose making the individual taxpayer the borrower to solve this problem. This enables the individual to either contribute the loan proceeds to the S-Corp or implement a mirroring note with the S-Corp as the borrower and the individual as the lender. Both options may help create the needed basis for the individual taxpayer in the S-Corp. This basis generation may be critical to the taxpayer if the taxpayer hopes to use the available income tax deductions from the aircraft in the acquisition year. Insufficient basis can delay the taxpayer’s ability to take deductions or limit the taxpayer’s ability to take distributions from their S-Corp without income tax liability.
Working with an aviation tax professional can help with the issues mentioned above. Once potential borrowers sort through these items, they will be better positioned to choose between financing or paying in cash based on what makes sense for their finances and cash flow rather than how it impacts their income tax deductions and tax planning.
By KJ McCarter, CPA, Aircraft Tax Advisor and Daniel Cheung, CPA, Principal at Aviation Tax Consultants, LLC.
NAFA members KJ McCarter and Daniel Cheung at Aviation Tax Consultants, LLC discuss the intersections of aircraft financing and aviation tax planning, including navigating ownership structures and basis generation.
