Aircraft Purchase, Ownership and Operation: Protecting the Interests of a Family Business Owner – Part 1 Access to private aircraft can provide productivity and other benefits for a family-operated business and improve the quality of life for the business owner and his family. However, purchasing, owning and operating a private aircraft requires careful consideration of a number of business, legal, tax and regulatory issues. These issues make it imperative that a small business owner consult with legal and tax counsel to ensure that the owner’s interests are properly represented in the purchase of the aircraft, that the owner purchases and operates the aircraft in a tax-advantaged structure, and that the owner operates the aircraft in strict accordance with the rules and regulations of the Federal Aviation Administration (FAA). This blog post provides an overview of several of the numerous issues that should be considered when purchasing, owning and operating a private aircraft and will be followed by additional blog posts providing a more detailed discussion on each of the issues raised below.

Initial Purchase of Aircraft

The first step in purchasing a private aircraft is often the preparation of a letter of intent (LOI) or other similar non-binding document setting forth the proposed terms for the purchase and sale of the aircraft.  The LOI is typically prepared by the purchaser and presented to the seller for consideration. Once the parties reach agreement on the general terms for the purchase and sale of the aircraft, the LOI is signed and legal counsel for the parties will prepare the aircraft purchase agreement (APA). The APA is particularly important to the purchaser as it provides the purchaser with rights to perform a thorough pre-purchase inspection and to perform other due diligence to ensure that the aircraft is in the condition represented by the seller or the seller’s broker.

Compliance with FAA Regulatory Requirements (Parts 91 and 135 Operations)

Privately owned aircraft are operated under either Part 91 or Part 135 of the FAA rules. Part 91 governs the operation of private aircraft for non-commercial, private carriage uses (e.g., flights for business and personal and family flights). Part 135 governs the use of private aircraft for charter flights and other commercial uses. Failure to comply with the FAA rules for the operation of a private aircraft can result in significant fines and liabilities, including the loss of insurance coverage for the owner and operator of the aircraft.

Liability of Owner/Operator of Aircraft

Owning and operating a private aircraft have the potential to expose an owner/operator to catastrophic loss. Many owners and operators are surprised to learn that they can be held liable for incidents of loss even when they are not piloting—or even onboard—the aircraft. Most risks associated with the ownership and operation of a private aircraft are not mitigated simply by titling the aircraft in the name of a separate legal entity, such as a corporation or limited liability company. Rather, the FAA extends legal and regulatory responsibility for flight operations to anyone who has “operational control” of the aircraft.

Sharing an Aircraft

Owners of private aircraft may enter into various types of arrangements to share ownership and/or use of an aircraft with others. Examples of such arrangements are leases, time sharing agreements, joint ownership, and charters. Each arrangement presents certain FAA regulatory compliance issues, risk allocation issues, and federal and state tax issues. This is true irrespective of whether the owner is sharing the aircraft with related parties (e.g., a subsidiary company, family members, etc.).

This is Part 1 in a series of blog posts by Wood Herren addressing various issues pertaining to the purchase, ownership and operation of private aircraft by family business owners. Stay tuned for Wood’s next post in this series, which will address other protections that an aircraft purchase agreement may provide a purchaser.

New Limitations on Deductions for Interest Payments May Impact Many Family BusinessesThe new Tax Cuts and Jobs Act limits the ability of many businesses to deduct interest payments. Under prior law, any interest expense was generally deductible. Now, many businesses are prohibited from deducting any interest expense that exceeds 30 percent of adjusted taxable income.

Before January 1, 2022, the formula for calculating net taxable income generally approximates EBITDA. Beginning in 2022, the formula will generally approximate EBIT. The EBIT formula will make the limitation even more restrictive for capital intensive businesses that finance equipment acquisitions with debt because they will be prohibited from adding back depreciation and amortization expenses to earnings for purposes of calculating the 30 percent limitation. When the EBIT formula becomes effective, it will apply to all debt regardless of whether incurred before or after 2022.

Several key points concerning the new limitation include:

  • The limitation does not apply to businesses with less than $25 million in average gross receipts for a trailing three-year period.
  • The gross receipts of related businesses are combined for purposes of the $25 million test. If the combined receipts exceed $25 million, the 30 percent limitation applies to each business.
  • Real property businesses (including development, construction, rental, management, leasing and brokerage businesses) are allowed to make an irrevocable election out of the business interest deduction limitation, but if so electing must use the alternative depreciation system for their nonresidential real property, residential rental property, and qualified improvement property.
  • Disallowed interest expenses may be carried forward indefinitely.

Family businesses subject to the new limitation should reassess their current debt profile. Beginning in 2022, family businesses in capital intensive industries may have little or no ability to deduct interest payments. In addition, family businesses that are looking to make a debt-financed acquisition, or that are considering a sale of their business, may be negatively impacted by the new limitation. It is generally anticipated that the limitation will raise the cost of debt-financed acquisitions.

New Tax Law Makes Asset Deals More Attractive for Family Business OwnersBuyers often prefer to structure family business acquisitions as taxable asset purchases. In a taxable asset purchase, the buyer is entitled to write up the basis of the seller’s assets to fair market value, and then going forward, receive a tax benefit by depreciating the assets. In addition, a buyer is entitled to amortize goodwill (i.e., the portion of the purchase price in excess of the fair market value of the purchased assets) over 15 years.

Under prior tax law, selling assets was often cost-prohibitive for a family business taxed as a C-corporation. The combined federal rate under prior tax law was 48 percent (resulting from a 35 percent corporate tax rate combined with a 20 percent tax rate on dividends received by non-corporate shareholders). When buyers insisted on an asset purchase and the owners of the seller were unwilling to pay half of their sales proceeds in taxes, the deal was likely to fall apart.

Under the new Tax Cuts and Jobs Act, the corporate tax rate was permanently reduced from 35 percent to 21 percent. The lower rate makes asset sales more attractive for sellers. Now, the combined federal rate is 36.8 percent, as compared to 48 percent under prior law. Asset sales are no longer as costly as they were for family business sellers.

Under the new tax law, there is also an additional incentive that makes buyers even more likely to favor asset acquisitions. The Tax Cuts and Jobs Act now allows for full expensing of most types of “qualified property” acquired after September 27, 2017. Significantly, “qualified property” includes used property acquired from any unrelated party. Because full expensing applies to used property, asset purchasers can now deduct the portion of the purchase price allocable to qualified property.

The lower corporate tax rate, together with immediate expensing of qualified property, makes asset deals more attractive for buyers and sellers.