Updated June 16, 2003
By Edward H. Kammerer, Edwards
& Angell, LLP
As a result of the Job Creation and
Worker Assistance Act of 2002, the rate at which owners of business aircraft
could claim depreciation benefits was significantly accelerated. The available
depreciation benefits of business aircraft ownership have been accelerated once
again with the passage of the Jobs and Growth Tax Relief Reconciliation Act of
2003.
This article is intended to serve
as a summary of the 2003 Tax Act and as a supplement to my April 2002 National
Business Aviation Association Website article on the subject.
Under the Modified Accelerated Cost
Recovery System ("MACRS"), owners of business aircraft have
historically enjoyed the ability to recover one hundred percent of the cost of
their business aircraft through depreciation deductions. The MACRS system of
accelerated depreciation provides for accelerated depreciation and effectively
accelerates or "front-loads" the depreciation benefits into the
earlier years of ownership. As a result of the 2002 Tax Act, owners of new
business aircraft have the option of taking 30% of the adjusted cost of a new
aircraft in the first year as "Bonus Depreciation." The remaining 70%
of the cost of their aircraft may be depreciated over the remaining tax life of
the aircraft beginning in the year acquired.
The rules governing the eligibility
of property for the 30% Bonus under the 2002 Tax Act remain unchanged with one
noteworthy exception enacted as a result of the 2003 Tax Act. The placed in
service date for 30% Bonus Property has been extended from "before
September 11, 2004" to "before January 1, 2005." In addition,
the 2003 Tax Act creates a separate class of property called "50-percent
bonus depreciation property." With the enactment of the 2003 Tax Act, the
Taxpayer has the option to treat qualifying property acquired after May 5, 2003
as "50% Bonus Property."
In order to be eligible for the 50%
Bonus, an aircraft must be "qualified property" within the meaning of
the Assistance Act. There are four basic requirements that must be satisfied in
order for an aircraft to qualify for the 50% Bonus. As applied to aircraft, the
requirements are:
Essentially, "qualified
property" is defined as property that is contracted for, purchased and
placed in service within a prescribed window of time.
The 2003 Tax Act does not create
additional depreciation benefits for aircraft owners. Rather, as illustrated
below, the 2003 Tax Act accelerates the depreciation benefits already available
to aircraft owners into the first year of ownership. The acceleration of tax
benefits in the form of increased depreciation deductions in the first year of
aircraft ownership effectively decreases the amount of depreciation deductions
in all subsequent years. This increases the importance of tax planning, as each
Taxpayer must make a determination that it will be able to use the accelerated
deductions in the years that they are available.
Assuming that placed in service
qualifications are otherwise met, it is possible that an aircraft could qualify
for either the 30% Bonus under the 2002 Tax Act or the 50% Bonus under the 2003
Tax Act. The taxpayer also has the option to elect not to claim either the 30%
Bonus or the 50% Bonus with respect to any aircraft. However, it appears that
such election must be followed with respect to all other aircraft in the in the
same class (e.g., all aircraft classified as 5-year property) that are placed
in service during that taxable year.
The 50% Bonus is applied in the
following manner. In the year that the aircraft is first placed in service, the
taxpayer may take a special depreciation deduction equal to 50% of the adjusted
basis of the aircraft. Thereafter, the depreciable basis of the aircraft is
reduced by the amount of the 50% Bonus for the purpose of calculating the
regular depreciation deduction for the year placed in service (i.e., depreciate
the remaining 50% of the basis of the aircraft over the applicable recovery
period).
For example, assume that Taxpayer
acquires a $10,000,000 aircraft in Year One. Assume further that the aircraft
is used in traditional corporate flight operations and thus is classified as
5-year property. (5-year property depreciates over a six-year period as a
result of the application of the Half-Year Convention.) Without the 50% Bonus,
the aircraft would be depreciated by Taxpayer as follows:
|
TABLE 1 |
|||||
|
Year |
Percentage Deduction |
|
Depreciable Basis |
|
Depreciation Amount |
|
1 |
20.00 |
x |
$10,000,000 |
= |
$2,000,000 |
|
2 |
32.00 |
x |
$10,000,000 |
= |
$3,200,000 |
|
3 |
19.20 |
x |
$10,000,000 |
= |
$1,920,000 |
|
4 |
11.52 |
x |
$10,000,000 |
= |
$1,152,000 |
|
5 |
11.52 |
x |
$10,000,000 |
= |
$1,152,000 |
|
6 |
5.76 |
x |
$10,000,000 |
= |
$576,000 |
|
Totals: |
100.00 |
|
|
|
$10,000,000 |
Under the 2003 Tax Act provisions,
Taxpayer is entitled to take a one time 50% Bonus in Year One. The remaining
50% of the aircraft's basis is depreciated over the six-year recovery period.
Thus, with the availability of the 50% Bonus, the aircraft will be depreciated
as follows:
|
TABLE 2 |
|||||
|
Year |
Percentage Deduction |
|
Depreciable Basis |
|
Depreciation Amount |
|
Bonus (Year 1) |
50.00 |
x |
$10,000,000 |
= |
$5,000,000 |
|
1 |
20.00 |
x |
$5,000,000 |
= |
$1,000,000 |
|
2 |
32.00 |
x |
$5,000,000 |
= |
$1,600,000 |
|
3 |
19.20 |
x |
$5,000,000 |
= |
$960,000 |
|
4 |
11.52 |
x |
$5,000,000 |
= |
$576,000 |
|
5 |
11.52 |
x |
$5,000,000 |
= |
$576,000 |
|
6 |
5.76 |
x |
$5,000,000 |
= |
$288,000 |
|
Totals: |
100.00 |
|
|
|
$10,000,000 |
Note that the total depreciation
benefit available to the Taxpayer in Year One equal $6,000,000. Note also that
the Depreciable Basis values set forth for Years One through Six in Table 2 are
equal to 50% of the Depreciable Basis values set forth in Table 1. The total
depreciation benefit available to Taxpayer is equal to 100% of the adjusted
basis of the aircraft under both methods of depreciation. With the 50% Bonus,
the depreciation benefit is accelerated into Year One with the result that the
depreciation benefits are smaller for Years Two through Six. Similar results
would be reached for an aircraft classified as 7-year property.
As previously stated, the 50% Bonus
does not result in additional depreciation deductions. The benefit of the 50%
Bonus is realized through the acceleration of depreciation deductions into the
year in which the aircraft is placed in service. Thus, bonus depreciation is
really a time value of money benefit. In order to determine the true value of
the 50% Bonus, each taxpayer must make a present value calculation of the
accelerated deductions taking into consideration the taxpayer's then current
marginal tax rate.
The Joint Explanatory Statement
issued by the House and Senate Tax Conference Committee illustrates how certain
previously ambiguous situations would be clarified as a result of the 2003 Tax
Act. Some examples follow.
The Conference Committee Report
contains good new for owners of new fractional aircraft interests. The Report
states that the first owner of a fractional interest in a new aircraft is
considered the "original user" of its proportionate share of
aircraft. Thus, although not expressly stated in the revised statute, it is
clearly Congressional intent that fractional interests in new aircraft will
qualify for the 50% Bonus.
The Conference Committee Report
also states that an aircraft acquired by a Taxpayer in a like-kind exchange or
as a result of an involuntary conversion would qualify for the 50% Bonus.
Also according to the Conference
Committee Report, leased aircraft that are sold by the original lessor to
another lessor within three months of the date the aircraft was originally
placed in service date will continue to be eligible for the 50% Bonus so long
as the identity of the original lessee/user of the aircraft does not change.
The Report recognizes that a technical correction bill may be needed to reflect
this intent.
Taxpayers should continue to review
the law of their particular state to determine whether the 50% Bonus will
reduce the amount of income that is taxable at the state level. Not all states
are following the Federal government's bonus depreciation rules.
The 2003 Tax Act provides
significant new tax benefits for purchasers of certain new business aircraft.
The particular facts and circumstances relating to the acquisition and use of
an aircraft continue to have a significant impact on a Taxpayer's eligibility
to utilize the 50% Bonus. The reader is advised and encouraged to consult his
or her tax and legal consultants for guidance concerning his or her particular
situation.
Edward H. Kammerer is a
commercial finance attorney concentrating in the areas of aircraft and
equipment leasing and finance and other corporate aircraft transactions. He is
a Partner in the law firm of Edwards & Angell, LLP in Providence, Rhode Island.
Ed also provides value-added counseling and service to his clients on a wide
range of business aviation issues, including: the structuring of ownership and
operation of business aircraft to comply with FAA regulatory, tax and risk
management planning concerns and objectives; leasing and finance; acquisitions;
sales and tax matters, including: federal income tax; aircraft depreciation and
expenses; excise, sales, use and property taxes and tax deferred like-kind
exchanges. Ed is a member of the National Business Aviation Association Tax
Committee and was a member of the Fractional Ownership Aviation Rulemaking
Committee. Ed can be reached at 401.276.6636 or ekammerer@EdwardsAngell.com.