The IRS Is Targeting Business Aviation: Are You Ready?

In February 2024, America’s tax collection agency – the Internal Revenue Service – announced that it will conduct dozens of audits focused on the personal use of business aircraft. These audits will target aircraft use by large corporations and partnerships and high-net-worth individuals, and are part of a broader agency effort – funded by the Inflation Reduction Act – to ensure that filers in these categories pay the taxes they owe.

“Specifically, these audits will examine the claimed allocation between business and personal use of business aircraft,” said Joanne Barbera, a founding partner of Barbera & Watkins and former chair of the NBAA Tax Committee. “At the same time, they’ll examine the deductions claimed related to that use, entertainment and commuting use and the income imputed to executives for personal use.”

For very large organizations, the potential penalties of business aviation audits may seem like pocket change. But there are other risks that these organizations might wish to avoid. For example, bad PR: Who wants to make front page news by being accused of cheating on their taxes?

A business aircraft audit can also expose other issues for the IRS to examine. According to Brent Snyder, a managing director at Andersen, “The big risk for companies is that in addition to finding issues with your handling of business travel, these audits can give the IRS reason to look more closely at the rest of your operations.”

While these initial audits are targeting tax evasion and avoidance among the wealthy, you probably shouldn’t think you’re out of the woods if you’re not a large corporation, large partnership or high-net-worth individual. Depending on what these audits turn up, and on IRS hiring of new examiners, scrutiny of personal use of business aircraft may scale up to include a far broader range of organizations.

How to Avoid an Audit

Organizations can take a variety of steps to reduce the chances of being targeted for an IRS audit:

1. Keep detailed, up-to-date records. This is by far the most important step that flight departments can take to stay out of trouble. The tax code requires contemporaneous record-keeping, at a passenger-by-passenger, leg-by-leg level of detail. If the IRS finds that your flight documentation records are current and in order, they’ll be far more likely to move on to the next organization on their list of potential audit targets.
2. Conduct your own audit. Business aviation taxes can be exceedingly complex, and it can be all too easy to miss an applicable test (such as business/hobby, active/passive, at-risk or qualified business use), miscalculate a figure or misclassify a flight. Checking your work via an internal audit – or, even better, one conducted by an expert third party – is the best way to understand your tax compliance picture and identify areas where you may have audit risk.

   “The recommendation of the NBAA Tax Committee, and of most tax experts, is to do your own audit to ensure that you’re not out of step with the tax code,” said Barbera.

   If you’re unable to conduct a full audit, at the very least be sure to review your records for recent years, checking that applicable tests are met, the documentation is adequate and flight classifications and calculations are accurate. Audits usually look at the past three years’ tax returns and hardly ever look at more than six years. To be sure that you’re minimizing your tax bill and remaining in compliance, understand the tax implications of your aircraft ownership and usage structures, and keep those structures up to date with changes to the tax code or your actual aircraft use.

3. Get everyone on the same page. To tell a credible, cohesive story explaining the claims you make on your tax returns, it’s crucial to gather all relevant information and understand the context in which all decisions were made.You can do this proactively by enabling and encouraging collaboration among knowledge-holders and decision-makers across your organization. Companies often accomplish this task by scheduling regular meetings to connect and align these people with their record-keepers and tax filers, helping them optimize tax returns while staying on strategy and in compliance.

   “The tax code for business aviation is very complex, and ensuring compliance is typically a multi-department exercise,” explained Ryan DeMoor, the current head of NBAA’s Tax Committee and the head of aviation tax at MySky, which provides aviation spend management solutions, including a tax reporting and compliance-management product. “It can involve everyone from the flight department to executives and their assistants to accounting, tax and legal.”

4. Make a plan to ensure operational continuity. In recent years, personnel turnover has been an issue in some flight departments. Unfortunately, many departing workers possess a great deal of hard-won knowledge of how and why certain decisions with tax implications were made. They take institutional and domain knowledge with them when they leave – knowledge that could improve tax compliance and help fend off audits.To avoid this scenario, have a succession and continuity program in place to aid in the hand-off of key insights when people with tax-related knowledge leave the team, and ensure that new employees have access to the resources they need to get up to speed on the issues. Connecting people across functional groups with tax-related knowledge will broaden the circle of expertise in your organization, helping to drive operating continuity.
5. Avoid obvious red flags. Tax examiners will be on the lookout for evidence that you haven’t paid attention to detail or been truthful. This can include:
   • • Failure to maintain contemporaneous flight records. The importance of keeping quality, up-to-date records cannot be stressed enough. “The tax code requires contemporaneous record-keeping,” said Barbera. “If you don’t do the documentation, you won’t get the deduction.”
     • Failure to analyze business use versus personal use. Explained Snyder, “It’s a red flag if you have obviously not been serious or detailed about analyzing business use versus personal use. Without good documentation, the IRS may be suspicious even if your records show that every flight was 100% business use.”
     • Inconsistency in how you approach similar tax situations. If you flip-flop your approach to tax issues for similar business situations over time, the IRS will likely have questions. The suspicion will be that you’re cherry-picking accounting approaches to get the best tax outcome.
     • Aggressiveness in flight classifications and tax calculations. Taking a conservative tax approach will serve you well if the IRS considers you for an audit. For example, you likely put your organization at increased tax risk if you consistently classify flights as being for business use based on the mere presence of potential business purpose, or if you consistently ignore personal activities related to mixed-use flights.

The bottom line: If the IRS really wants to audit your use of business aircraft, it’s going to find a way to do so. But taking these steps will make your organization a far less attractive target – and help improve the outcome if you are audited.

How to Navigate an IRS Audit

The audit process begins with a letter from the IRS notifying you that you’re being audited, identifying the items on your tax return(s) that are in question and requesting documentation to support your claims.

Remember: This is not a time to panic. There’s a lot to do, and not a lot of time to do it. According to Barbera, “It can take a lot of time to pull together all your resources in the timeframe the IRS wants.” To do it right, it’s crucial to be efficient, responsive and analytical.

What to Do When You’re Audited by the IRS

The first task at this point is to respond to the IRS with the evidence that supports your approach to the issues identified in the audit letter, by the indicated IRS deadline. (A timeless piece of advice: Always pay attention to the deadlines in IRS correspondence.)

To put together the most convincing possible response, you’ll need to do the following:

• Gather your team. Bring together a cross-functional team of people with the information and knowledge required to prepare your response to the IRS. This can include everyone from the flight department, to accounting and legal, to executives and executive assistants (who often possess key evidence supporting your stance on the issues, from emails discussing reasons for travel, to receipts for business events). Connecting and getting tax-relevant information and documentation from all these people can take time, so you’ll be significantly ahead of the game if you’ve created this team proactively.
• Get your records together. This can be a major time suck if you haven’t been taking record-keeping seriously. “It may seem like a lot of work to keep contemporaneous records for every passenger on every flight leg,” said Barbera. “But if your records aren’t in order, it’s a big deal if you get audited.”
• Get expert help. Most companies facing an audit benefit from working with an expert third party – an accountant, attorney or consultant – to help them successfully navigate the process. According to Snyder, it’s crucial to include one particular outside expert: “My recommendation is that those facing an audit should include their tax preparer in the process. It’s not without cost, but the tax preparer will understand what information the IRS is looking for and know how to answer questions.”

When to Appeal an IRS Audit

“You should look at, and question, every one of the audit’s findings,” said DeMoor.

This is unquestionably good advice, as the IRS is far from immune from making mistakes. But at the same time, it’s important to understand that even if you do have a strong argument for appealing audit findings, there may be good reasons not to. Factors to consider when deciding whether to appeal include:

• Legal costs. According to Snyder, “On appeals, you really need to work with an attorney. Legal questions will arise, and there may be issues where you’ll benefit from the protection of attorney-client privilege.” As most readers will be aware, attorney’s fees can add up fast.
• Your current state of compliance. Have you fixed the issues the IRS is looking at? Or, as DeMoor put it, “Have you reformed your ways?” If you can show that you have, it can help your argument on appeal – especially if you can demonstrate you’ve been doing so for an extended period of time.
• The expected ROI of an appeal. It’s critical to do a cost-benefit analysis of your appeal before moving forward. Does the potential benefit of the appeal outweigh the cost? How strong is your case? How unimpeachable are your arguments? “Look at the issues at hand, calculate your risks and decide whether it’s worth it to appeal,” said Barbera.

Finally, it’s worth noting the potential impact on this issue of the recent U.S. Supreme Court decision ending the so-called “Chevron deference,” which recognized federal agencies’ power to interpret and enforce laws. According to DeMoor, this decision potentially opens the door for companies with tax issues related to the personal use of business aircraft to push back on the IRS’s interpretation of tax law. But DeMoor acknowledges that his take is speculative; whether audit targets can leverage the end of the Chevron deference to fight IRS audits remains to be seen.

Review NBAA resources about business aviation tax issues at nbaa.org/taxes