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Personal Use:
Impact on the Company Ruth Wimer - McDermott, Will & Emery
Doug Stewart - AircraftLogs
Live NBAA Webinar| May 29, 2012
Agenda & Objectives
• Introductions Wimer
• Fictional Case Study – Jackson Power Stewart
• IRS Entertainment Disallowance
– Overview of the Entertainment Disallowance Wimer
– Sample Calculation of Entertainment Disallowance Stewart
– Strategies for Maximizing Tax Deductions Wimer
• SEC Proxy Disclosure Requirements
– Overview of SEC Proxy Requirements Stewart
– Strategies for Minimizing SEC Proxy Disclosures Wimer
• Deductibility of Charitable or Lobbying Flights Wimer
• Questions & Answers
2
• Live NBAA Webinar| May 29, 2012
Summary Notes
Personal Use: Impact on the Company
In this session, the group participants will learn the key
differences between a personal entertainment flight and a
personal, non-entertainment flight. They will learn how the IRS’s
entertainment disallowance rule reduces a company’s annual tax
deductions. The participants will also learn about SEC proxy
disclosure requirements applicable to personal flights by certain
individuals. Armed with a general understanding that certain
flights can reduce a company’s tax deductions and increase its
public disclosures, our presenters will discuss:
– Calculating the IRS entertainment disallowance and the SEC
proxy disclosure amounts
– Strategies to maximize tax deductions and minimize SEC
proxy disclosures
– Deductibility of flight expenses attributable to charity or
lobbying activities
3
• Live NBAA Webinar| May 29, 2012
Agenda & Objectives
• Introductions Wimer
• Fictional Case Study – Jackson Power Stewart
• IRS Entertainment Disallowance
– Overview of the Entertainment Disallowance Wimer
– Sample Calculation of Entertainment Disallowance Stewart
– Strategies for Maximizing Tax Deductions Wimer
• SEC Proxy Disclosure Requirements
– Overview of SEC Proxy Requirements Stewart
– Strategies for Minimizing SEC Proxy Disclosures Wimer
• Deductibility of Charitable or Lobbying Flights Wimer
• Questions & Answers
4
• Live NBAA Webinar| May 29, 2012
Our Case: Jackson Power Industries
• Electrical Contractor for
the Utility Industry
• Founded by J. Walter
Jackson, Chairman &
CEO, age 63
• Led by J. Walter Jackson
Jr., President
• 4000 employees across the southwestern US
• Publicly-traded on NASDAQ beginning in 1999
• Headquarters in St. Louis
5
• Live NBAA Webinar| May 29, 2012
Business Aviation Profile
• Falcon 2000 owned by Jackson Power Industries
– Based in St. Louis (KSUS)
– The company’s first aircraft
– Acquired in 2011 for $17 million
– Four pilots and a scheduler on staff
– $2 Million Annual Operating Costs
• Common uses of the aircraft:
– Transport sales executives and marketing teams
– Transport project managers to utility work sites
– Weekly commutes of CEO from his home in Colorado Springs
– Provide personal transportation to Jackson family
6
• Live NBAA Webinar| May 29, 2012
A Typical Week – Five Trips in October 2011
1. Monday Morning Commute
– Aircraft flies to Colorado Springs to pick up Jackson Sr.
– Roughly 4 hours round trip
2. Monday Afternoon – Round trip to Pittsburgh (2 VP’s)
3. Tuesday – Round trip to Atlanta office (2 VP’s)
4. Wednesday – Round Trip to Chicago (2 Engineers)
5. Thursday – Combined Trip to Pittsburgh & Boston
– Two Sales Reps fly to Pittsburgh
– Jackson family (family of four) rides along for drop off on
Boston (starting a week of vacation)
– Aircraft returns Pittsburgh, takes the two Sales Reps home
7
• Live NBAA Webinar| May 29, 2012
Three Areas of Impact to Jackson Power
1. Calculate SIFL Impact for Employees with Personal
Use of the Aircraft (covered last week)
2. Calculate Entertainment Use Disallowance
– Quarterly Calculation of Entertainment Disallowance for Tax
Provision (in the corporate financial reporting)
– Annual Calculation of SIFL for Employee Personal Use
– Annual Disallowance as part of Corporate Return
3. Disclose Incremental Cost in the Annual Proxy
Statement
– Compensation Disclosures for Named Executive Officers
(NEO’s)
– Related party transactions, if applicable
8
• Live NBAA Webinar| May 29, 2012
Agenda & Objectives
• Introductions Wimer
• Fictional Case Study – Jackson Power Stewart
• IRS Entertainment Disallowance
– Overview of the Entertainment Disallowance Wimer
– Sample Calculation of Entertainment Disallowance Stewart
– Strategies for Maximizing Tax Deductions Wimer
• SEC Proxy Disclosure Requirements
– Overview of SEC Proxy Requirements Stewart
– Strategies for Minimizing SEC Proxy Disclosures Wimer
• Deductibility of Charitable or Lobbying Flights Wimer
• Questions & Answers
10
• Live NBAA Webinar| May 29, 2012
Aircraft Expense Disallowance
• Summary: American Jobs Creation Act of 2004 (“AJCA”) requires
companies to disallow the cost of personal entertainment flights
provided to “specified individuals”.
– This calculation becomes a percentage of your aircraft use
– IRS Notice 2005-45 explained “how” to disallow – and severely
impacted the deductibility of corporate aircraft.
• Many companies still unaware and fail to disallow.
– Often its caused by a process breakdown
– Critical data never gets from the flight department to the reporting
team or tax staff.
– Preventing a portion of your overall aviation expenses from being
deductible on the company tax return
• Makes the flight department look expensive
11
• Live NBAA Webinar| May 29, 2012
What Are We Disallowing?
• Four Methods of Calculation – but each deal with occupied seats
– Before AJCA, only the business purpose of the flight mattered
– Now, the business purpose of every passenger matters
• Example: Chairman on business trip, family rides along
– Before AJCA: 100% deductible – No problem
– After AJCA : spouse & two children – 75% is non-deductible
• Your Data Matters. Your Flight Patterns Matter!
– Example: $2 Million operating budget and $5 Million of depreciation
– Disallowing only 30% could cost the company $840,000 (40% of 30%
of $7MM)
12
• Live NBAA Webinar| May 29, 2012
Classification of flights
Business (B) – No SIFL
income/Expenses are fully
deductible
Personal Non-Entertainment
(PNE) - Report SIFL income.
Expenses are fully deductible.
Personal Entertainment (PE) -
Report SIFL income. Expenses
not deductible (except for SIFL
amount or reimbursements).
Employer-provided flights
B - Business PE – Personal
Entertainment PNE - Personal
Non-entertainment
Report SIFL Disallowed Expenses
Report SIFL income Fully deductible
Time sharing agreement Calculate Disallowance Percentage:
Flight by Flight method Occupied seat method
No SIFL income Fully deductible
13
• Live NBAA Webinar| May 29, 2012
Category #1 – Business flights
• Includes only flights that are ordinary and necessary to
the company’s business
• A “business” flight can include business entertainment
where the entertainment portion was “before during or
after” business discussions, associated with or related
to the taxpayer’s business or directly business related
14
• Live NBAA Webinar| May 29, 2012
Spouse, family and personal guests
• Spouses: Just say no!
• Almost never be considered an ordinary and necessary
business expense.
• Taxable fringe benefit to the employee
• Must consider whether the spouse is traveling for
entertainment or non-entertainment purposes.
15
• Live NBAA Webinar| May 29, 2012
Category #2 – Personal non-entertainment
• Examples of Personal Non-Entertainment Flights not
subject to the disallowance
– Commuting to and from work, or travel between residences
– Investment activity
– Director meetings of unrelated company
– Meetings with broker, attorney, accountant
– Doctors visits
– Funerals
– Charitable activities
– Children to and from school or visiting colleges
16
• Live NBAA Webinar| May 29, 2012
Category #3 – Entertainment
• Treasury Regulation §1.274-2(b)(1)(i) generally defines
“entertainment” as “any activity which is of a type generally
considered to constitute entertainment, amusement or recreation,
such as entertaining at night clubs, cocktail lounges, theatres,
country clubs, golf and athletic clubs, sporting events, and on
hunting, fishing, vacation and similar trips.”
• Objective test shall be used.
• Examples of entertainment: ALL VACATIONS, weddings and other
parties, visiting well relatives such as children in college, and
entertainment activities with business associates where not
attached to actual business discussions or activities.
17
• Live NBAA Webinar| May 29, 2012
Expenses
• All costs of maintaining and operating the aircraft
• Proposed Regulations: …includes, but is not limited to, salaries for
pilots, maintenance personnel and other personnel assigned to the
aircraft, meal ad lodging expenses of flight personnel, take-off and
landing fees, costs for maintenance flights, costs of on-board
refreshments, amenities and gifts, hangar fees (at home or away),
management fees, costs of fuel, tires, maintenance, insurance,
registration, certificate of title, inspection, and depreciation: and all
costs paid or incurred for aircraft leased or chartered, to or by the
taxpayer.
• Interest?
18
• Live NBAA Webinar| May 29, 2012
Employer provided flights – allocation of costs
• “Occupied seat method” or the “flight by flight” method
• Allocate costs based on each passenger’s primary
purpose for traveling
• Calculation may be performed in either hours or miles
• Annual choice between these two methods, and
between miles and hours
• Must use same method for all planes
19
• Live NBAA Webinar| May 29, 2012
Deadhead Flights Must be Tracked
• Flight with no passengers
• Same number of passengers traveling for the same
purposes as the occupied flight to which the deadhead
flight relates
• Note that Deadhead must count for the Entertainment
Disallowance, but not for income inclusion (SIFL)
purposes
20
• Live NBAA Webinar| May 29, 2012
Specified Individuals
• Officers, directors and 10 percent owners
• Spouse, Family and Personal Guests:
– Such flights are considered provided to the specified individual
for purposes of the entertainment disallowance, because of the
relationship to the specified individual
• “Officers” are defined by reference to securities laws
– “vice presidents in charge of a….”
• Example: Jackson Power considers SVP’s and above
to be specified individuals
– No IRS impact unless personal entertainment use occurs – less
likely to overlook
21
• Live NBAA Webinar| May 29, 2012
Agenda & Objectives
• Introductions Wimer
• Fictional Case Study – Jackson Power Stewart
• IRS Entertainment Disallowance
– Overview of the Entertainment Disallowance Wimer
– Sample Calculation of Entertainment Disallowance Stewart
– Strategies for Maximizing Tax Deductions Wimer
• SEC Proxy Disclosure Requirements
– Overview of SEC Proxy Requirements Stewart
– Strategies for Minimizing SEC Proxy Disclosures Wimer
• Deductibility of Charitable or Lobbying Flights Wimer
• Questions & Answers
22
• Live NBAA Webinar| May 29, 2012
Aircraft Financial Summary
• Aircraft acquired in 2011 for $17M
– Direct Operating Costs: $1 million (Fuel, Mx, Engine reserves)
– Fixed Costs: $1 Million (Salaries, hangar, insurance, etc.)
– Depreciation will be $5.5 million in 2012 (6 year MACRS, half
year)
• Approx. 400 flight hours per year:
– 100 hours of personal entertainment use by the CEO, President
and their guests
– 200 hours of business
– 100 hours of commuting
23
Jackson Power will have about $7.5 million of cost subject to disallowance rules this year…
• Live NBAA Webinar| May 29, 2012
Typical Weekly Flight Patterns
St. Louis
Chicago Boston
Atlanta
Pittsburgh
Colorado Springs
Monday & Friday Commute of Jackson Sr.
Frequent Flights to Regional Office
Locations
24
• Live NBAA Webinar| May 29, 2012
Review: Five Trips in October
1. Monday Morning Commute
– Aircraft flies to Colorado Springs to pick up Jackson Sr.
– Roughly 4 hours round trip
2. Monday Afternoon – Round trip to Pittsburgh (2 VP’s)
3. Tuesday – Round trip to Atlanta office (2 VP’s)
4. Wednesday – Round Trip to Chicago (2 Engineers)
5. Thursday – Combined Trip to Pittsburgh & Boston
– Two Sales Reps fly to Pittsburgh
– Jackson family (family of four) rides along for drop off on
Boston (starting a week of vacation)
– Aircraft returns Pittsburgh, takes the two Sales Reps home
25
• Live NBAA Webinar| May 29, 2012
These Trips will Trigger the Following…
St. Louis
Chicago Boston
Atlanta
St. Louis
Pittsburgh
Colorado Springs
Monday & Friday Commute of Jackson Sr.
Frequent Flights to Regional Office Locations
1. SIFL Income to Jackson Sr.
2. Disallowance of costs associated with the Boston trip
3. SEC disclosure of the incremental cost to the company of providing personal use to Jackson Sr.
26
• Live NBAA Webinar| May 29, 2012
Occupied Seats Matter
• Example: Executive on a business trip, spouse & two
children ride along for fun
– Before AJCA: The plane was departing for business – No
problem
– After AJCA : spouse & two children – 75% is non-deductible
• Your Data Matters. Your Flight Patterns Matter!
• Jackson Power has $7.5 million of cost at stake
– $2 million of departmental costs
– $5.5 million of depreciation
27
• Live NBAA Webinar| May 29, 2012
Disallowance Impact to Jackson Power
• Just a 1% Swing Equals $75,000
Direct Operating Costs: $1,000,000
Fixed Costs: 1,000,000
Depreciation: 5,500,000
SIFL 4,437
Costs Subject to Disallowance $7,495,563
• Difference of almost $2 Million between Methods!!
– Seat Hours: 45.79% or $3.43MM
– Seat Miles: 40.77% $3.06MM
– Flight Hours, Flight By Flight: 26.31% $1.97MM
– Flight Miles, Flight By Flight: 21.82% $1.64MM
28
• Live NBAA Webinar| May 29, 2012
Comparing the Four Disallowance Methods
• Small Annual Passenger Volume (~30 or less): Large
variations in all four methods may result – personal use
has a big impact
• Large Passenger Volume: As the volume of
passenger travel increases (100 or more), the results
have a tighter dispersion
• Flight Patterns Matter: If Personal Trips are typically
longer than Business Trips, Seat Hours may provide
better results (Miles accumulate faster than Hours on
long trips)
• Flight By Flight Method: Often helpful to offset trips
with large group of personal travelers 33
• Live NBAA Webinar| May 29, 2012
Agenda & Objectives
• Introductions Wimer
• Fictional Case Study – Jackson Power Stewart
• IRS Entertainment Disallowance
– Overview of the Entertainment Disallowance Wimer
– Sample Calculation of Entertainment Disallowance Stewart
– Strategies for Maximizing Tax Deductions Wimer
• SEC Proxy Disclosure Requirements
– Overview of SEC Proxy Requirements Stewart
– Strategies for Minimizing SEC Proxy Disclosures Wimer
• Deductibility of Charitable or Lobbying Flights Wimer
• Questions & Answers
34
• Live NBAA Webinar| May 29, 2012
Strategies for Maximizing Tax Deductions
• Substantiate, Substantiate, Substantiate
• Not substantiating can lead to denial of characterization
of flight as a business flight, or a flight as a non-
entertainment flight
• Ensure all flights which will not be disallowed have clear
and contemporaneous documentation
• Calculate deduction disallowance all four ways and pick
lowest disallowance year by year
• Draft and follow policy minimizing permitted personal
entertainment use.
35
• Live NBAA Webinar| May 29, 2012
Strategies (cont’d)
• Analyze all “personal” flights to ensure proper treatment
• Attempt to combine business trips and entertainment
trips
• Minimize deadheads for personal entertainment;
conversely, be sure to properly include seat hours/miles
for business deadheads in your disallowance
calculation
• Multiple Aircraft?
– Consider the impact of grouping like aircraft together
– Consider utilizing aircraft with lower tax impact for personal
entertainment flights
36
• Live NBAA Webinar| May 29, 2012
Agenda & Objectives
• Introductions Wimer
• Fictional Case Study – Jackson Power Stewart
• IRS Entertainment Disallowance
– Overview of the Entertainment Disallowance Wimer
– Sample Calculation of Entertainment Disallowance Stewart
– Strategies for Maximizing Tax Deductions Wimer
• SEC Proxy Disclosure Requirements
– Overview of SEC Proxy Requirements Stewart
– Strategies for Minimizing SEC Proxy Disclosures Wimer
• Deductibility of Charitable or Lobbying Flights Wimer
• Questions & Answers
37
• Live NBAA Webinar| May 29, 2012
SEC – Annual Reporting to Shareholders
• Proxy Statement: Must Disclose the “Value” of Aircraft
Personal Use for each “Named Executive Officer” (NEO)
– Amounts exceeding $10,000 must be disclosed in the
company’s “Summary Compensation Table”
– Amounts exceeding the greater of $25,000 or 10% of total
perquisites require separate footnote explanation
– Generally, included under “All Other Compensation”
• Value = “Aggregate Incremental Cost” (AIC) of Providing
the Compensation. Significant variations in calculations
across reporting companies.
“Just one non-business round trip between LAX and Teterboro can trigger SEC reporting requirements.”
38
• Live NBAA Webinar| May 29, 2012
SIFL Income & Proxy Disclosures of AIC
• SIFL and Proxy disclosures go
“hand in hand”
• For NEO’s, the AIC disclosure
is closely related to the flights
which require SIFL
• SIFL can be disclosed for
informational purposes, but
does not satisfy AIC disclosure
requirements
• The incremental cost is
generally much greater than
SIFL
Sample :Round Trip LAX & TEB
Gulfstream G-IV
SIFL:
$3,941 / person
Incremental Cost: ~ $27,000
Retail Charter:
~ $60,000
39
• Live NBAA Webinar| May 29, 2012
Methods of Computing AIC
• Summary: Those costs which the company would not
have incurred but for the personal use of the plane by
an NEO or their guests
• Significant variations among reporting companies, but
some common practices include
– Exclusion of fixed costs (salaries, depreciation, maintenance)
– Inclusion of variable costs (fuel, trip-related expenses)
– Exclusion of flights where business passengers are aboard
(negligible incremental cost for personal use passengers)
– Use of published hourly operating costs
– Use of actual hourly operating costs
40
• Live NBAA Webinar| May 29, 2012
Sample of a Proxy: General Electric
NEO’s AIC
Disclosure of Time Sharing Agreement with NEO
41
• Live NBAA Webinar| May 29, 2012
Sample Footnote (Phillip Morris)
• The amounts shown are the incremental cost of
personal use of Company aircraft to Phillip Morris and
include the cost of trip-related crew hotels and meals,
in-flight food and beverages, landing and ground
handling fees, hourly maintenance contract costs,
hangar or aircraft parking costs, fuel costs based on
the average annual cost of fuel per hour flown, and
other smaller variable costs.
• Fixed costs that would be incurred in any event to
operate Company aircraft (e.g. aircraft purchase costs,
depreciation, maintenance not related to personal
trips, and flight crew salaries) are not included.
42
• Live NBAA Webinar| May 29, 2012
Other AIC Disclosure Samples
…..based on the aggregate incremental cost to the Company using a
method that accounts for fuel, maintenance, landing fees, other
associated travel costs and charter fees.
… includes the incremental cost of relocating aircraft to
accommodate personal trips and the incremental costs of flights for
______ and ______ to attend outside board meetings for the public
companies and government institution at which they serve as outside
directors.
… is determined by multiplying the total 2011 personal flight hours by
the incremental aircraft cost per hour. The incremental aircraft cost
per hour is derived by adding the annual aircraft maintenance costs,
fuel costs, aircraft trip expenses and crew trip expenses, and then
dividing by the total annual flight hours.
43
• Live NBAA Webinar| May 29, 2012
Jackson Power – Aggregate Incremental Costs
St. Louis
Chicago Boston
Atlanta
St. Louis
Pittsburgh
Colorado Springs
Monday & Friday Commute of Jackson Sr.
Frequent Flights to Regional Office Locations
Assume $3000/hour (you should track actuals)
3.9 hours for Monday’s commute 4.0 hours between Pitt & Boston 7.0 hours x $3,000 = $21,000 this week (vs. $25,000 threshold) (note – we have included the deadhead BOS > PIT)
44
• Live NBAA Webinar| May 29, 2012
Agenda & Objectives
• Introductions Wimer
• Fictional Case Study – Jackson Power Stewart
• IRS Entertainment Disallowance
– Overview of the Entertainment Disallowance Wimer
– Sample Calculation of Entertainment Disallowance Stewart
– Strategies for Maximizing Tax Deductions Wimer
• SEC Proxy Disclosure Requirements
– Overview of SEC Proxy Requirements Stewart
– Strategies for Minimizing SEC Proxy Disclosures Wimer
• Deductibility of Charitable or Lobbying Flights Wimer
• Questions & Answers
45
• Live NBAA Webinar| May 29, 2012
Time Share Arrangements
• Summary: Under Part 91.501(c)(1), a time-sharing agreement
allows an aircraft operator to be reimbursed for a limited set of
costs for a flight.
• “Two Times Fuel” - Corporate flight departments often provide
time-sharing arrangements, allowing an executive to reimburse the
company for personal use of the aircraft. These arrangements
require specific tracking of ten eligible costs on each flight:
1. Fuel, oil, lubricants, and other additives.
2. Travel expenses of the crew
3. Hangar and tie-down costs away from home base)
4. Insurance for a specific flight
5. Landing fees, airport taxes, and similar assessments.
6. Flight-specific customs, foreign permits, and similar fees
7. In-flight food and beverages.
8. Passenger ground transportation.
9. Flight planning and weather contract services.
10. An additional charge equal to 100 percent of the expenses listed in item 1 (fuel)
Time-sharing arrangements usually trigger
excise tax!
46
• Live NBAA Webinar| May 29, 2012
Reimbursement Strategies
• Time Sharing Agreements – Reimbursements can
approximate “net incremental cost”, reducing the
magnitude of the “other compensation” disclosure.
– Requires disclosure of a related party transaction
• Reimbursement under the “Nichols Re-interpretation”
– Full reimbursement under specified circumstances (executive
must be on board for personal purposes, spouse/dependents
notwithstanding)
– May require Form 8K filing
An emerging trend is for executives to reimburse the company via time sharing agreements.
47
• Live NBAA Webinar| May 29, 2012
Leads to “Related Party Transactions”
• Securities & Exchange Commission (SEC) also
requires disclosure of “related-party” transactions
• Transactions between the executives & the company
• Proxy Excerpt below:
48
• Live NBAA Webinar| May 29, 2012
Executive-Owned Aircraft
• Summary: Often, a company executive may own the aircraft, and
lease it back to his/her employer.
• Leads to more internal accounting, depending on the nature of the
arrangement:
– Dry leases
– Time shares
– Etc.
• Implications: For both Executive-Owned Aircraft and Time-
Sharing Arrangements, the executives involved and the company
will need to “settle up” periodically (“who owes who?”). The data
provided by the flight department will directly affect these
calculations.
• Settlements will often occur quarterly, in order to be finalized for
SEC reporting purposes
49
• Live NBAA Webinar| May 29, 2012
Section 162(m)
Disallowance for Public Companies
• IRS guidance on the entertainment disallowance
supports the position that the Section 162(m) limitations
only apply to the amount included in the executives W-2
for entertainment flights
• Query: Can the same position be taken for non-
entertainment flights?
50
• Live NBAA Webinar| May 29, 2012
Agenda & Objectives
• Introductions Wimer
• Fictional Case Study – Jackson Power Stewart
• IRS Entertainment Disallowance
– Overview of the Entertainment Disallowance Wimer
– Sample Calculation of Entertainment Disallowance Stewart
– Strategies for Maximizing Tax Deductions Wimer
• SEC Proxy Disclosure Requirements
– Overview of SEC Proxy Requirements Stewart
– Strategies for Minimizing SEC Proxy Disclosures Wimer
• Deductibility of Charitable or Lobbying Flights Wimer
• Questions & Answers
51
• Live NBAA Webinar| May 29, 2012
Deductibility: Charitable & Lobbying Flights
• Only “out of pockets” for charitable flights are deductible
• Lobbying Flights are not deductible pursuant to section
162(e) which applies to “certain” lobbying expenses
• A solution is to “SIFL” the passenger, and then the
remainder is deductible in some instances.
52
• Live NBAA Webinar| May 29, 2012