The U.S. Tax Court denied an aircraft owner the “bonus” tax depreciation available for business aircraft because it did not have a conference table. Despite the adverse result, the case offers valuable lessons on how to use, and substantiate the use of, business aircraft for tax purposes and how the IRS and courts approach cases involving private aircraft.
The relevant facts are simple. On December 30, 2003, Michael Brown, an insurance salesman who sold $10 million to $300 million life insurance policies to wealthy individuals for estate planning purposes, purchased a $22 million business aircraft in Portland, Oregon. On the same day, Mr. Brown flew his newly acquired aircraft to both Seattle and Chicago for business meetings. These flights allowed Mr. Brown to claim a bonus tax depreciation deduction on the aircraft of approximately $11.2 million in 2003. In early 2004, a conference table and larger televisions were installed on the aircraft. The Internal Revenue Service (IRS) audited Mr. Brown, and ultimately denied the bonus tax depreciation deduction that Mr. Brown claimed for the aircraft, on the theory that the aircraft was not “placed in service” because the conference table was not installed until 2004. The Tax Court agreed with the IRS and imposed a 20 percent accuracy-related penalty.
Mr. Brown’s aircraft had a typical interior seating configuration, but he wanted a conference table in the aircraft that he could “use [ ] for business,” and that he “needed it for his mission.” Accordingly, the Tax Court determined that “The conference table was now a necessity.” Mr. Brown also wanted the standard 17-inch display screens replaced with 20-inch screens so that he could make better PowerPoint presentations to potential clients and other insurance agents. Mr. Brown contracted for these interior modifications in December 2003, and the work was performed in early January 2004.
Mr. Brown claimed bonus tax depreciation of almost $11.2 million on the aircraft as an expense for his insurance business for 2003. Upon audit, the IRS disallowed that deduction, and the Tax Court agreed that Mr. Brown could not properly claim bonus depreciation on the aircraft for 2003 because the aircraft was not “placed in service” that year since the conference table was missing and the larger display screens had not yet been installed.
The bonus depreciation sought by Mr. Brown would have allowed him to deduct 50 percent of the aircraft’s purchase price, but only if the aircraft was acquired and “placed-in-service” in 2003. The Treasury Regulations state that “[p]roperty is first placed in service when first placed in a condition or state of readiness and availability for a specifically assigned function.” The IRS argued that the aircraft was not in a condition or state of readiness and availability for a “specifically assigned function,” which was to operate as Mr. Brown deemed necessary for his insurance business, because the conference table and larger display screens were not installed until 2004.
Mr. Brown testified at trial that the conference table and larger display screens were “needed” and “required.” The Tax Court found that the aircraft was not available for its intended use until those modifications were made because Mr. Brown “needed” these “seemingly minor touches.” In post-trial briefs, Mr. Brown downplayed the significance of the improvements and argued that they had “nothing to do with the [aircraft’s] assigned function of transporting him for his business.” The Tax Court treated this argument as “post-trial framing [that] just doesn't square with the trial testimony” and determined that the aircraft was not “placed in service” in 2003, and imposed hefty penalties and interest.
Surprisingly, the Tax Court imposed a 20 percent accuracy-related penalty. Mr. Brown argued that the tax penalty should not apply because he relied on “substantial authority,” which was the “express language of the Internal Revenue Code,” and that he told others “that he needed to use the [aircraft] in his business before the end of the year to claim bonus depreciation.”
The Tax Court was unpersuaded, in part because Mr. Brown did not offer Treasury Regulations or pertinent case law to support his “substantial authority” position until late in the case. The Tax Court ruled that Mr. Brown’s subjective belief that he relied upon “substantial authority” was irrelevant because whether “substantial authority” exists is an objective standard involving an analysis of the law and its application to the relevant facts. Therefore, the Court found that Mr. Brown did not establish “substantial authority” to claim the bonus depreciation deduction for 2003 and upheld the accuracy-related penalty.
The teachable moments from this case are many:
This case is a cautionary tale for business aircraft owners taking delivery at the end of the tax year. Prior to year-end, the aircraft should be used for documented, legitimate business flights. If there are any desired improvements for the aircraft that have not been completed prior to the delivery, hold off on contracting for, or making, those improvements until after the aircraft is in a condition or state of readiness and availability for its specifically assigned function of passenger flight services (not flying conference room).
Gary I. Horowitz is Special Counsel with the Washington, DC law firm Wiley Rein LLP, where he represents private and commercial aircraft operators, owners, lessors and financiers in structuring the sale, acquisition, ownership and operation of aircraft, and providing federal tax and state sales and use tax planning services.