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A bill that would exempt aircraft management fees from the federal air transportation excise tax is advancing in the House — good news for aircraft owners who use a leasing company structure to save on state sales tax when purchasing aircraft.

The bill (H.R. 3608) clarifies that fees paid to an aircraft services company to provide pilots, flight services and to manage maintenance for a company that is leasing an aircraft are not subject to the 7.5 percent federal excise tax on air transportation. This bill arises out of a case where the IRS said that NetJets was subject to the excise tax for the fees it received for such flight management services. NetJets won this case in federal court, because the court found that the IRS did not give adequate notice that the tax was applicable to such aircraft management services fees. So without Congressional approval or further action, the IRS could decide to give proper notice to aircraft services companies, which would then be legally require them to collect the federal excise tax on their fees.

If this bill becomes law, it would be good news for a common  sales tax planning technique involving aircraft purchases that is accepted in many states. This technique involves setting up a separate aircraft leasing company (ALC) that is owned 100 percent by the person or company (end-user) acquiring the aircraft. The ALC then leases the aircraft to the end-user on a dry-lease basis.  The advantage of an ALC structure is that in many states, the ALC can purchase the aircraft exempt from sales and use tax, because it is purchasing the aircraft solely for the purpose of leasing it to the end-user and others. Sales tax would be due on the monthly dry-lease payments, so this technique trades off the big upfront sales tax payment on the purchase of the aircraft for the much smaller sales tax due on the monthly lease payments, resulting in a sales tax deferral.

However, in order to use the ALC structuring technique properly, the end-user must ensure that it enters into a dry lease in respect of the aircraft – meaning that such end-user (as lessee) will be responsible for, among other things, the operation and maintenance of the aircraft, If the lease does not qualify as a dry lease, then the entire lease payment could be subject to the 7.5 percent federal transportation excise tax under existing law if the IRS provides notice of application of the tax. End-users routinely enter into management agreements regarding operation and maintenance support in connection with their entry into dry leases. If H.R 3608 becomes law, this would assure that the fees paid to an aircraft services company will not become subject to the federal excise tax, resulting in complete excise tax savings on both the dry lease payments and the management services fees.

The House Ways and Means Committee cleared this bill on July 13. A companion bill has been introduced in the Senate. Those involved in the aviation industry should be interested in the progress of this legislation.

To see the text of H.R. 3608, click here.

To the see the Joint Committee on Taxation’s explanation of this bill, click here.