The IRS has issued final regulations (T.D. 9597) that severely restrict an employer's ability to deduct costs incurred for entertainment, amusement or recreation travel by certain employees ("specified individuals"--generally, 10-percent owners and partners, officers, and directors). The tax code limits the deduction for expenses on flights taken primarily for personal enjoyment to the amount of compensation included in the income of the employees who take the flights. Costs exceeding the amount of compensation thus are not deductible by the employer.
The final IRS regulations require that all fixed and variable costs be taken into account in determining the nondeductible portion (and, in effect, the deductible portion) of airplane expenses for entertainment travel. These costs include fuel, pilot salaries, depreciation, landing fees, hangar fees, and allocable interest expense. The IRS rejected comments that it should exclude fixed costs from the calculation of nondeductible costs.
Under the final regulations, employers may elect to use straight-line depreciation to calculate the nondeductible depreciation, even if the employer uses accelerated depreciation for other calculations. The election must apply to all aircraft. The final regulations limit the depreciation deduction to 100 percent of the aircraft's cost. Otherwise, a transition rule could result in the disallowance of more than the aircraft's cost.
Allocation of costs
The IRS had requested comments on allowing employers to use a charter-rate safe harbor to determine expenses paid or incurred for entertainment flights. While many commentators endorsed this approach, the IRS in the end concluded it would be too difficult to determine accurate and reliable charter rates for a safe harbor. However, the IRS reserved the authority to adopt a safe harbor in future guidance.
In the final regulations, the IRS adopted two methods for allocating aircraft expenses between entertainment and non-entertainment use. These include the occupied seat hours or miles allocation method, and the flight-by-flight method. The first method divides total annual expenses by occupied seat hours or seat miles, and applies the resulting rate to the number of hours or miles of entertainment use. The second method divides total annual expenses by the number of flight hours or miles, and then applies the resulting rate to the passengers on a flight.