The S corporation is becoming the business entity of choice, especially among small to medium-sized owners.
Tax efficiency, ease of ownership, and operational simplicity are just a few reasons why you may choose an S corporation for your business structure.
But when it comes to aircraft ownership, S corporations may leave you and your tax savings grounded.
This article will explore the top three pitfalls of an S corporation owning an aircraft and the strategies you need to know to avoid tax headaches.
1. Basis Limitations
The tax code makes it incredibly difficult for business owners to deduct losses, especially S corporation owners. From basis limitations to the recent addition of the excess business loss limitation rules, it is becoming more difficult for you to claim losses on your return.
The main benefit of aircraft ownership in a business structure is the resulting loss you generate by taking first-year bonus depreciation or the Section 179 deduction. Your business write-off of an aircraft in the first year of ownership creates an immediate tax benefit, especially if you are leveraging debt to finance the purchase of your aircraft.
Example 1. Say you purchase a $1 million aircraft with $200,000 cash and $800,000 from a secured note. For 2024, the tax code currently allows for 60 percent first-year bonus depreciation,1 for an immediate deduction of $600,000. On the remaining $400,000 basis, you could deduct another $80,000 in MACRS depreciation2 for a total first-year write-off of $680,000.
If you are at the top tax rate of 37 percent, your federal tax savings would be $251,600 in the first year, effectively meaning the government gives you the cash for the down payment.
Not So Fast!
If you purchase that aircraft through an S corporation, those tax savings may be limited. Generally, you can claim losses only to the extent of your basis in your stock and any shareholder loans to your S corporation.4 Unlike in a partnership entity structure, debts of the S corporation to a third-party lender will generally not give you the basis you need to claim big losses.
Key point. If you will use an S corporation to own an airplane, make sure you have the necessary basis to deduct the losses you want.
Tax planning tip 1. Avoid debt financing the purchase of an aircraft by an S corporation. Use cash instead.
Tax planning tip 2. If the S corporation needs more cash, take a personal loan and then lend those proceeds to the S corporation before purchasing the aircraft.
Depreciation Recapture
Generally, the tax code gives you two methods for depreciating an aircraft: the modified accelerated cost recovery system (MACRS) and the alternative depreciation system (ADS). The aircraft used predominantly (more than 50 percent) in a business will be depreciated under MACRS, while an aircraft failing that 50 percent test will be subject to ADS.
To get the big deductions up front, you need more than 50 percent business use of your airplane to claim bonus depreciation.6 If you fail the 50 percent business use test, you must use the distasteful ADS, which means straight-line depreciation over a six-year8 or 12-year recovery period.
To the keep the original big deductions, you need to keep your business use above 50 percent because the tax code deems airplanes “listed property,” a classification that triggers special depreciation recapture rules.
Example 2. You purchased that $1 million aircraft and claimed bonus depreciation in Year 1. In Year 2, your business use falls to 40 percent.
Now, your corporation must redo your Year 1 depreciation using the applicable ADS method. Ouch! That means goodbye bonus and MACRS depreciation, and hello straight-line depreciation.
Does this mean you can never let your business use of that aircraft fall to less than 50 percent? No!
Aircraft depreciation recapture is often misunderstood as a recapture of all prior-year depreciation. But when business use falls below 50 percent, your corporation recaptures only the excess MACRS depreciation over ADS. Assuming the aircraft is fully depreciated under ADS (generally after seven years), your S corporation has no excess depreciation to recapture.
What if you want to take the airplane out of the S corporation? You can’t simply take it. It’s not yours. It’s the S corporation’s.
If you want the S corporation to give the aircraft to you, either the S corporation has to treat it as a distribution or you have to buy it at fair market value.
And this sale by the S corporation to you or to any other person triggers depreciation recapture subject to tax at ordinary income tax rates.
Example 3. Your S corporation has fully depreciated the airplane. It gives the plane to you, the sole shareholder. At that moment, the aircraft has a fair market value of $900,000. The S corporation has $900,000 of recapture income (ordinary income) that passes to you on your K-1.
3. Cost-Sharing Arrangements
Because of the high cost of aircraft ownership, business owners may want to share the cost with others. If you have multiple owners in the business, you might want to allocate the aircraft cost based on owners’ usage.
Unfortunately, the S corporation offers no ability to allocate aircraft expenses to owners based on use. The S corporation must allocate tax items pro rata based on the shareholder’s ownership.13 That makes the S corporation a lousy entity for cost-sharing arrangements.
Tax planning tip 1. Don’t use an S corporation for aircraft ownership if you want to eventually own the aircraft personally.
Tax planning tip 2. If you want the S corporation’s aircraft, wait until the aircraft’s fair market value has dropped to where you can absorb the taxable income hit.
Example 4. You and your business partner are looking to share the cost of an aircraft. You own an S corporation 50/50 but would like to split the aircraft costs based on use, which will be 20 percent by you and 80 percent by your partner.
Forget it. Your S corporation treats the airplane as an S corporation property. On its tax return, it allocates net income (after the aircraft expenses) on a 50/50 basis.
Tax planning tip. Use a partnership structure to allow for special allocations.
Takeaways
Choosing an S corporation as your business entity offers many advantages, including tax efficiency and operational simplicity. But when it comes to aircraft ownership, significant pitfalls can negate these benefits. Here are the top three issues to be aware of.
1. Basis Limitations
Challenge. S corporation owners often face restrictions in deducting losses due to basis limitations. Debts to third-party lenders do not increase your basis.
Example. A $1 million aircraft purchase by an S corporation might result in limited tax savings if financed by a third-party lender.
Tip. Use cash instead of debt for aircraft purchases, or take a personal loan and contribute the proceeds to the S corporation to increase basis.
2. Depreciation Recapture
Challenge. If you don’t keep business use of the aircraft above 50 percent, your S corporation likely suffers depreciation recapture, which flows through to your personal tax return, increasing your taxes.
Example. Shifting from say 89 percent business use to 40 percent business use requires the S corporation to recapture as ordinary income any excess of bonus and MACRS over ADS depreciation.
Tip. Keep business use above 50 percent.
3. Cost-Sharing Arrangements
Challenge. S corporations don’t allow specific allocation of expenses to owners.
Example. A 50/50 ownership split cannot accommodate different amounts of aircraft use (e.g., 20 percent versus 80 percent).
Tip. Consider a partnership structure for more flexible cost allocations.
