S Corp. can deduct cost of private jet use.

• Author: McNamara, Emer

A recent Chief Counsel Advice (CCA), 200344008, provided a very favorable outcome for S corporations that own aircraft used personally by shareholders and employees. For years, the IRS argued that the personal use of a company-owned asset limited the employer's deduction to the amount included in the employee's income. Armed with case law and the recent CCA, employers should no longer suffer the penalty of limited deductions when offering certain benefits to their employees or shareholders.

Facts

In the CCA, an S corporation was engaged in the active conduct of a trade or business and owned fractional interests in two jet aircraft. The S shareholders were members of a single family. Flight logs documented that approximately 5% of the aircraft's use was for business purposes; the remaining 95% was for personal use by shareholders and two non-shareholder employees.

The S corporation properly determined the values of the personal flights under Regs. Sec. 1.61-21, using the Standard Industry Fair Level (SIFL) formulas, and reported those values in shareholders' and employees' compensation. (In general, the value of personal flights taxable to employees using SIFL does not correspond with the employer's actual costs of providing the flights.) In the CCA, the depreciation and operating expenses were more than 10 times the compensation reported to the shareholders and employees. The CCA determined that the S corporation could deduct all the expenses attributable to owning and operating the aircraft, not just the compensation reported to share holders and employees.

Deducting Compensation

Sec. 162 allows a deduction for ordinary and necessary business expenses, including compensation paid for personal services. However, Sec. 274(a)(1)(A) can disallow an expense solely for entertainment, amusement or recreational activities. A vacation or personal trip aboard a company aircraft constitutes entertainment under Regs. Sec. 1.2742(b)(1) and, thus, would fall under this disallowance provision.

Under Sec. 274(e)(2), however, entertainment expenses included in an employee's income are exempt from the Sec. 274(a)(1)(A) disallowance rules. Temp. Regs. Sec. 1.162-25T provides that when compensation is paid in the form of a noncash fringe benefit, an employer may deduct its cost in providing the benefit if the value is included in the employee's gross income. When the amount treated as compensation exceeds the corporation's actual cost, Temp. Regs. Sec...