July 2002

Noncommercial Aircraft Travel Deduction

By Kent Swift

In a recent appellate case, the court again upheld the deduction allowed for the personal use of a company airplane by corporate employees. In Sutherland [255 F.3d 495, (CA-8, 2001)], the Eighth Circuit Court of Appeals affirmed a March 2000 Tax Court ruling that a corporation’s deductions for expenses incurred in providing an airplane for executive employees’ vacation flights were not limited to the amount taxed to the employees as compensation for the flights; that is, the company was allowed to deduct the full operating costs. This decision affects more than just deductions for aircraft used for vacation flights because it affirms that the entertainment deduction rules in IRC section 274(a) and 274(e)(2) do not limit a company’s deduction for providing an entertainment or recreational fringe benefit to the amount properly charged to employees as compensation income. Two recent Tax Court cases have also reached similar conclusions.


The facts of the original case [Sutherland, 114 T.C. 197 (2000)] are straightforward. Sutherland Lumber-Southwest, Inc., a corporation with its principal place of business in Kansas City, Missouri, is a lumber retailer with outlets located in eight Texas cities. The company owned a 1976 Model 25 Learjet used for travel related to the lumber business and for its charter service business operating out of Kansas City. Two officers of the corporation also used the plane for travel related to their positions as directors of other companies, for other business and charitable purposes, and for vacation travel.

In 1992, the plane was used approximately 35% for the charter business and other purposes directly related to Sutherland, 24% for vacation travel, and 41% for charitable travel, travel by the owners as directors of other companies, and travel related to other businesses. In 1993, the plane was used approximately 28% for the charter business and other purposes directly related to Sutherland, 24% for vacation travel, and 48% for charitable travel, travel by the owners as directors of other companies, and travel related to other businesses. Use of the aircraft for purposes other than the charter service or directly related to Sutherland (i.e., the director’s flights, flights for other businesses, charitable flights, and vacation flights) was properly reported by the officers as compensation in connection with their employment with the corporation.

The actual cost of operating the plane for purposes other than the air charter service or Sutherland business was substantially greater than the amounts reported as income by the officers. The IRS allowed all of the plane costs related to the air charter business, the lumber business, charitable flights, and flights related to other businesses, but disallowed the deduction of the plane expenses to the extent the cost of the vacation flights exceeded the amounts reported by the officers.

Limitations on Deductions of Certain Entertainment Expenses

Under IRC section 162, businesses are generally allowed to deduct all ordinary and necessary deductions in carrying on their business. Moreover, companies may deduct expenses paid as compensation, including noncash fringe benefits, as an ordinary expense. The amount included in income by the employee, however, is the value of the benefit received, while the amount deducted by the employer is the cost incurred in providing the benefit. These two amounts are not always the same and, in fact, may drastically differ.

IRC section 274 was enacted to curb perceived abuses with business deductions for entertainment and travel expenses and for gifts. IRC section 274(a)(1) generally disallows deductions involving entertainment, amusement, or recreational activity. It also disallows the deduction for expenses incurred for a facility used in connection with such an activity.

Although section 274(a)(1) is designed to generally prohibit deductions for certain entertainment-related expenses, section 274(e)(2) provides that the disallowance rules under IRC section 274(a) will not apply to expenses treated as compensation. Specifically, it provides that section 274(a) will not apply to entertainment “expenses for goods, services, and facilities, to the extent that” they are included as compensation to an employee on the company’s income tax return. The question addressed by the Tax Court in Sutherland is whether Congress intended the words “to the extent that” to exempt companies that treat the benefit as compensation from the IRC section 274(a) limitations entirely, or whether it intended to limit a company’s deduction to the amount included in income by employees.

Valuation of Employer-Provided Flights in Noncommercial Aircraft

Generally, employee fringe benefit income is computed using the fair rental value of the property less any reimbursement. For some benefits, however, Congress has provided specific valuation rates and methods. For employer-provided flights in noncommercial aircraft, the amount included in income is a percentage of commercial flight fares intended to approximate coach and first-class fares.

Under Treasury Regulations section 1.61-21(g)(5), the value of a flight is generally computed using the three-step standard industry fare level formula (SIFL):

Control employees include board members, officers (limited to the lesser of 1% of all employees or 10 employees), the top 1% most highly paid employees of the company (limited to a maximum of 50), and employees with more than a 5% ownership interest in the employer.


Assume a control employee flies 2,000 miles in the company airplane and the maximum weight of the plane is 15,000 lbs. The following amount would be included in income:

Step 1: Cents-per-mile calculation:
(500 $0.2031) + (1,000 $0.1548) + (500 $0.1489) = $330.80
Step 2: Multiple for weight of plane and control/non-control employee:
$330.80 300% = $992.40
Step 3: Addition of terminal charge:
$992.40 + $37.12 = $1,029.52=Employee Compensation

The important point is that the amount included by the employee as compensation bears little relationship to the actual costs incurred in operating the aircraft. Such an approach can result in differences between the amounts deducted by the company as an expense and reported by the employee as compensation. In some cases, such as Sutherland, it is possible that the employee would be required to report a lower value as compensation income than the company deducts as an expense.

This difference can be dramatic. In a recent Tax Court memo decision [National Bancorp of Alaska, Inc., TC Memo 2001-202 (2001)], the cost allocated to personal entertainment use of a Gulfstream G-11B jet aircraft by employees was $734,096 during 1996. The value of the fringe benefit included as compensation income of the employees was only $131,575. The IRS disallowed this excess deduction and assessed a tax deficiency against the company of $216,918. Citing Sutherland, the Tax Court found in favor of the taxpayer and allowed the excess deduction. In a similar case [Midland Financial Co. and Subsidiaries, TC Memo 2001-203 (2001)], the Tax Court also found in favor of the taxpayer and allowed the deduction of aircraft expenses in excess of the amounts reported as compensation by employees.

The Decision in Sutherland

Returning to Sutherland, the Tax Court found in favor of the taxpayer, ruling that IRC section 274(e)(2) exempts vacation-related aircraft deductions from the general disallowance rules of IRC section 274(a). Therefore, Sutherland’s deductions for operation of its jet in connection with vacation flights were not limited to the amount reported as compensation by its employees.

The Tax Court also noted that the mismatch of deductible expenses and reportable compensation does not necessarily always favor the taxpayer. In some situations, it is possible that the opposite result could occur. The employer might be limited to deducting the costs incurred, even though the employee might be required to report income in excess of the allowable deduction.

Tax Planning for Employee Use of Noncommercial Aircraft

In an Action on Decision dated February 11, 2002, the IRS conceded the deduction issue for noncommercial aircraft expenses allowed in Sutherland. Specifically, the IRS stated that it will no longer litigate this issue in cases where a taxpayer demonstrates that it has properly included in compensation the value of an employee vacation flight in accordance with Treasury Regulations section 1.61-21(g). The IRS will, however, continue to throw out the cost of noncommercial aircraft for vacation flights if the value of such flights is not included in the employee’s compensation. Because of the large sums involved, it is in the taxpayer’s best interest to properly calculate the amount of compensation from the use of noncommercial aircraft for nonbusiness purposes and include this amount in wages.

Kent Swift, PhD, CPA, is a professor at Zayed University, Dubai, United Arab Emirates.

Edwin B. Morris, CPA
Rosenberg Neuwirth & Kuchner

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