On July 31, the IRS issued final regulations relating to the disallowance under Sec. 274 of deductions for the use of business aircraft for entertainment (T.D. 9597). The final regulations adopt, with some modifications, proposed regulations issued in 2007 (REG-147171-05), which in turn followed principles first expressed in Notice 2005-45. (For prior coverage, see Pressey, Stebbens, and Koopmans, “New Prop. Regs. Clarify Tax Deductible Entertainment Use of Private Aircraft,” 38 The Tax Adviser 646 (November 2007).)
In 2004, Congress limited expense deductions for executives’ use of business aircraft for entertainment (Sec. 274(e)(2)). This provision limits the deductibility of personal entertainment use by those with control over the business’s costs (referred to as “specified individuals”) to the amounts included in the specified individual’s income or to the amounts of reimbursement. Specified individuals include officers, directors, more-than-10% owners, 10% shareholders, 10% equity partners/members, and managing partners/members of a partnership/LLC.
The regulations define “entertainment air travel” as “travel aboard a taxpayer-provided aircraft for entertainment purposes” (Regs. Sec. 1.274-10(b)(2)). However, they also specify that “[e]ntertainment does not include personal travel that is not for entertainment purposes” (Regs. Sec. 1.274-10(b)(1)). The preamble to the proposed regulations explained that entertainment use does not include travel for business, medical purposes, attending a funeral, or participating in charitable events.
Disallowed expenses include variable costs such as fuel and landing fees, and fixed costs such as depreciation, hangar fees, pilot salaries, and other items not directly related to an individual flight. They also include interest expense if the underlying debt is secured by or properly allocable to an aircraft used for entertainment. A taxpayer may aggregate expenses for aircraft of similar cost profiles to calculate expenses subject to disallowance.
The methods of allocating costs to flights are based on occupied seat hours or occupied seat miles (defined as the total hours or total miles flown by passengers multiplied by the number of occupied passenger seats). The total aircraft operating costs for the tax year are divided by occupied seat hours or occupied seat miles to arrive at cost per occupied seat hour or occupied seat mile.
Costs can also be allocated on a flight-by-flight method. This method divides the total aircraft operating costs for the tax year by the number of flight hours or flight miles for the year to determine cost per hour or cost per mile, and each flight is allocated a cost based on its miles or hours. The cost per flight is then allocated to its passengers on a per capita basis.
“Deadhead” flights—when an aircraft flies without passengers en route to pick up or after having discharged passengers—are treated as having the same number and character of passengers as the leg of the trip on which passengers are on board. The regulations include examples illustrating the computation of expenses for deadhead flights.
Expenses allocable to a period during which the private aircraft is leased or chartered to an unrelated party for full and adequate consideration in a bona fide business transaction are not considered for the limitation calculation.
The final regulations do not include specific rules for the use of aircraft as entertainment facilities, but they clarify that Sec. 274(e)(2) and the regulations apply to expenses for entertainment facilities as well as entertainment activities.