Financial advisors to aircraft owners should be on notice that unanticipated tax consequences may result from the acquisition, transfer or simple use of aircraft inside states that otherwise would appear to have no basis for taxing the aircraft.

Financial advisors to aircraft owners should be on notice that unanticipated tax consequences may result from the acquisition, transfer or simple use of aircraft inside states that otherwise would appear to have no basis for taxing the aircraft. 

As a result of a recent decision by the Illinois Supreme Court, nonresident owners of mobile property (such as an airplane) face the very real possibility that the use of such property in Illinois will result in a use tax assessment. Taken together, the decision in Irwin Industrial Tool Company and other national developments highlight the importance of education and effective planning when it comes to aircraft ownership and state taxes.  In particular, financial advisors must be vigilant and creative to avoid falling into a number of state tax traps that are being laid by state administrative tax departments in response to continuing budgetary woes.  

The Irwin decision ultimately affirmed the Illinois Department of Revenue’s position that nonresidents must pay a use tax when they land their airplanes in Illinois even if the airplane is based in another state.  In the Irwin case, the Department claimed it had authority to tax nonresident Irwin Industrial Tool Company on the full purchase price of its airplane under the Illinois Use Tax Act. The Nebraska-based company purchased its airplane Kansas, took possession of it in Arkansas, and thereafter hangared it in Nebraska. 

The Illinois Supreme Court agreed with the Department of Revenue, finding it especially relevant that Irwin maintained a corporate office in Illinois; that four out of Irwin’s seven corporate officers had their offices in Illinois; that the airplane made a total of 272 take-offs or landings at Illinois airports; that 36.9 per cent of the total flight segments for the airplane were logged on flights to and/or from Illinois; and that the airplane was present overnight in Illinois on 25 occasions.

Therefore following Irwin, advisors should be on alert that their clients’ use of planes in states with which they have an otherwise minimal connection may still result in a use tax liability.  While credits might be available for any tax previously paid to another state on the aircraft, the mere fact that the aircraft is based or hangared in another state is not enough to protect a nonresident owner from inquiry by the state.

A second trap for the unwary owner or advisor stems from taxes, which may be assessed upon the transfer of a plane from one entity to another during a corporate restructuring.  While many states provide tax exemptions for transfers that occur as a result of tax-free reorganizations, state statutes must be examined closely to determine the state sales/use tax consequences of a particular restructuring. 

For example, the Illinois Department of Revenue has stated that the transfer of an airplane by a corporation to one of its affiliates for liability protection purposes constitutes a “transfer” under the Illinois Aircraft Use Tax and is therefore subject to tax.  This transaction is a relatively common and otherwise seemingly harmless transaction that many companies and individuals undertake.  Special purpose entities are often established to own aircraft in an effort, among other things, to protect the original owner from liability.  Advisors with clients who are involved in aircraft acquisitions or transfers must realize that the simple act of transferring title to an aircraft from one owner to another could result in an unintended sales/use tax consequence.

Another potential trap involves entities and individuals owning fractional interests or shares in aircraft.  Generally speaking, fractional aircraft ownership is shared ownership of a personal aircraft that is staffed and maintained by a management company. 

The laws applicable to fractional interests will vary depending on the specific provisions of the contract between the management company and the fractional interest owner.  Once the rights under the contract are understood, the sales tax laws of the applicable jurisdictions must be analyzed to determine whether a tax liability will attach to the purchase. 

Advisors with clients involved in such programs would be wise to acquaint themselves with the sales tax rules not only of the jurisdictions where the interest was purchased and where the aircraft is kept, but also the rules of the management company’s headquarters and of the various jurisdictions where the aircraft will be used. 

To illustrate, a Michigan decision from 2009 held that the purchase by a Michigan company from NetJets Aviation of a 25 per cent undivided interest in an airplane was taxable under the state’s Use Tax Act even though the actual airplane purchased never entered Michigan.  The court reasoned that the corporation “used” its fractional ownership interest within Michigan when it exercised its right under its contract with NetJet to use other airplanes in the NetJet fleet.

As states continue to struggle financially, your clients can expect to see an increase in aggressive enforcement of tax laws.  For aircraft owners and their financial advisors, the expanded definition of “use” after Irwin, combined with the crucial importance of details in corporate restructurings and the varying approaches to the taxation of fractional interests, means that effective tax planning is now more critical than ever. 

Exploring options such as participation in Voluntary Disclosure or Tax Amnesty programs is recommended.  Depending on the exact circumstances, aircraft owners may be able to avoid an Irwin-type tax liability by closely monitoring time spent in different states with an eye toward taking advantage of states’ “fly-away” exemptions. Generally speaking, such exemptions provide a safe-harbor to nonresident aircraft owners who remove their planes from the state of purchase within a specified period of time after purchase and who do not return to the state during another specified period of time. 

For example, California requires the aircraft to be "promptly removed from the state and is not returned to California within 12 months after its removal from the state" to qualify for the “fly-away” exemption.  Additional requirements vary state-by-state, necessitating a close look at applicable statutes prior to determining the best approach for tax purposes. 

It is also strongly recommended that airplane owners keep close track of taxes paid to various states in connection with the purchase, transfer or use of an aircraft, as most if not all states provide a system of crediting taxes owed for taxes previously paid.  The exact rules involved can be quite complex, making accurate record-keeping essential.  For financial advisors, understanding the tax consequences of aircraft ownership is an essential step toward assuring clients that their aircraft acquisitions are, in every sense, well advised. 

David A. Hughes is an attorney with Horwood Marcus & Berk in Chicago. Carolyn Sprinchorn is a contract attorney with the firm.

Editor’s Note:  The author’s firm represented Irwin Industrial Tool in its Illinois use tax litigation.