For businesses with significant annual expenses related to air travel, properly allocating personal entertainment flight expenses for tax purposes can be a valuable method for finding potential deductions. However, federal regulations provide multiple methods for calculating those costs, so determining which method to use is important.
Expenses allocable to operating an aircraft for specified individuals’ personal entertainment flights only are deductible to the extent those individuals include the value of the flights in income, plus any amount the specified individual reimburses the taxpayer. Specified individuals generally are officers, directors or those who own more than 10 percent of the business.
Business entertainment flight expenses are not limited, and business entertainment flights are not subject to the usual 50 percent reduction of entertainment expenses allowable as a deduction. Business entertainment air travel is any entertainment air travel aboard a taxpayer-provided aircraft directly related to the active conduct of the taxpayer’s trade or business or related to an expenditure directly preceding or following a substantial and bona fide business discussion and associated with the active conduct of the taxpayer’s trade or business.
Not all personal use by specified individuals is considered entertainment use. For example, travel to attend a family member’s funeral is not entertainment.
When determining the cost allocable to personal entertainment flights, all direct and indirect costs of operations are to be taken into consideration, including, but not limited to:
Depreciation for purposes of this allocation is calculated using the straight-line method over the class life of the aircraft—generally six years. Note: The amount of disallowed depreciation expense allocated to personal entertainment use does not reduce the basis of the aircraft, so this amount should be tracked for determination of gain or loss on subsequent disposition of the aircraft.
IRS regulations offer two methods for allocating costs and each can use miles or hours, resulting in four different calculations to determine costs allocable to specified individuals’ personal entertainment use: the occupied seat method using either miles or hours and the flight-by-flight method using either miles or hours. The same method must be used to allocate costs for all personal entertainment flights during a taxable year. Since these methods do not affect the timing of deductions, they are not accounting methods, meaning a different method for allocating disallowed costs may be selected each taxable year. Therefore, to reduce lost deductions, it's important to calculate the costs allocable to personal entertainment use by specified individuals each taxable year using all four methods and select the method resulting in the least cost disallowance.
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