"Capitalization versus repair has always been a contentious issue, and there has been no clear guidance. The distinction between capital expenditures and ordinary and necessary business expenses evades easy description. Between the two extremes a point is approached at which it is difficult to determine whether the expenditure is capital or an expense." Burris said it boils down to individual circumstance and facts, as decided by trial court.



Burris cited IRS guidance including letter ruling 9618004, where each periodic major engine inspection was considered to add a new service life of four years, reasoning that the inspections are required for the airworthiness certificate and without inspections the taxpayer would be unable to operate.

"One of the things the IRS conveniently forgot is that when you depreciate an aircraft, you take into account normal maintenance," noted Burris. Still, ordinary and necessary business expenses make for deductible repairs, while the IRS says repairs adding to the property's value or prolonging its life must be capitalized. In considering what portion is subject to regulation, management or tax accounting, Burris advised operators to ask, "Does the engine or airframe have any use without the other?"

One court found that FedEx engine shop visits (ESVs) did not materially increase the value of its aircraft, or adapt the property to another use, and were therefore ordinary and necessary business expense and a deductible maintenance repair. One factor was that FedEx removed its engines for maintenance, put in a spare, then made that original engine a spare once repaired; an ordinary Part 91 operator might take the aircraft from service for a prolonged period, making for a different circumstance for tax and trial purposes.

Patrick Dowdall, a manager with Atlantic Exchange Co., said that corporations might use a like-kind exchange to defer capital-gains taxes or depreciation recapture, but only if structured properly. A Section 1031 exchange of property held for productive use in a trade or business, as opposed to holding for resale, is eligible. Fractional interests qualify.

"You can exchange for other fractional shares or for an entire aircraft but the IRS approach is that transportation excise tax applies since the program organizer has 'possession and control,'" said Dowdall, reiterating a common forum theme.

After a partial withdrawal, the IRS is under pressure to get tough, said Mary Hevener, of law firm Baker and McKenzie. Hevener had litigated the pivotal Sutherland Lumber case for about $100,000.

"For those of you not familiar with litigation, that's really cheap," she said.

High-flying stock schemes collapsed on their own after the tech boom, though the IRS had not even been auditing. "We've had only two audits in the last six years for all of my Fortune 500 clients on compensation issues. Now, in the wake of Enron, the IRS felt like the weak sister in these hearings when it was questioned as to why it wasn't fulfilling its watchdog obligations. And lots of press coverage is raising questions about the use of business aircraft by executives. Now one of my clients, with a four-person tax department, has 23 IRS agents on its tail."

"This level of audit is now in test with 24 companies," noted Hevener, listing eight points of IRS attention. "They're looking at the 20 highest-paid executives at each company, the same ones most likely to fly on the corporate aircraft."

The IRS attack centers on fringe benefits, which include the personal use of corporate aircraft, and executive compensation subject to the cap of $1 million in deductibility via Code 162(m). The new thrust could upset the deductibility precedents from the Sutherland case, which allowed full cost of aircraft operation to be deducted, not just SIFL rates. Hevener predicts challenges, given lingering questions as to whether flights are treated as a business expense or as income.

Tim Tammany, of Cigna Corp., tackled the complex arena of the federal excise tax (FET) on fuel and transport, imposed on some Part 91 and most Part 135 ops. In response to a call by attendees for an all-day forum on the topic, Mike Nichols of NBAA promised to pursue a two-hour addition to this year's annual meeting workshop schedule to focus on the excise tax, in which participants might complete a mock Form 720. Tammany praised the NBAA guidance on FET available in full via its Web site, which is even cited by the IRS in its own guidelines.

Alvaro Pascotto, counsel with Morrison and Foerster of Los Angeles, measured the hazards of personal use, whether the purely tax or public relations aspects. "The use of an aircraft by an executive in a public company has many implications in today's regulatory environment," said Pascotto, noting that Sarbanes-Oxley (the Public Company Accounting Reform and Investor Protection Act of 2002), which addresses financial disclosure and transparency as well as ethical conflict, has become the beacon for today's accountant.

"The IRS requires that owners and executives either pay for personal use or be taxed as having received a fringe benefit." Pascotto said that valuation of a non-commercial flight docks in a safe harbor, "if accurately and consistently applied using the SIFL for all employees. Otherwise, fringe-benefit valuation of personal flights is made using charter rates-that is, the fair market value." The IRS recognizes only those two valuation methods.

Pascotto cited multiple legal precedents allowing a flight to be accounted as business. In each case the company proved that the aircraft was a time saver; enabled a number of meetings in one day; saved money by eliminating delays; and enhanced customer service. The legal victories are virtually a testimonial to NBAA's Travel$ense software, which can help quantify these factors.

Pascotto crafted a sample manifest and recommended its completion regardless of the passenger load, though if at least 50 percent of the passenger seating capacity (excluding the jump seat) is occupied with business passengers, there is no taxable income charge for employees, their spouses and dependent children.

"If the personal use is treated as taxable business compensation, that's deductible," though he emphasized that the de minimis threshold for business use must remain at least 25 percent of the year for active conduct of the taxpayer's trade, not in connection with entertainment. Pascotto, like others, underlined the Sutherland Lumber precedent.

"The IRS will no longer litigate in cases in which a taxpayer demonstrates that it has properly included in compensation and wages the value of an employee vacation flight in accordance with Treasury Regulation 1.61-21(g)," he concluded, though with a proviso. "But stay tuned to this issue."

Pascotto wrapped his presentation, and captured the day's tone, with a quote from Warren Buffett about financial disclosure. "Well, it seems to me that, in terms of getting better disclosure, there are four possible choices," said Buffett. "One is the law. Second, the media. The third would be the owners. And the fourth would be conscience. I think the media can be very helpful and have been very helpful."

For more details, visit http:// web.nbaa.org/public/ops/taxes/ for links to all forum topics, or call Mike Nichols at (202) 783-9254. The next NBAA tax committee event will be the 13th Annual Tax Conference in Las Vegas on October 10 and 11.