When thinking about risk management, and advising aircraft owners about how they operate, the first question that comes to mind is the basics of safety, not how the Federal Aviation Administration (FAA) sees "whose fault it was." The risk manager, however, is all about fault. You never want to be the one with it. It's like a game of whack a mole.
Not meaning to be negative here, but lawyers and accountants can complicate the dynamic. To be clear, despite the hordes of lawyers that surround aircraft and jet owners, the simple fact is that few really grasp how the cogs in all the wheels work when the great gears of aircraft ownership start clunking away. There's money in those clunks, and there's even income, depreciation, and then, well, there's also a good portion of mine fields.
When dealing with private and corporate aviation, related management and acquisition projects, there is typically consistent theme when the person writing the check thinks to themselves, "How am I going to set this up?" For those of you are that aren't familiar with the concept, you know it anyway—when you are able to scare one gopher (or pesky problem) into one hole, another rears its head out somewhere else. Put another way, beware of any adviser who tells you that you can have your cake and eat it too.
Gopher #1: the FAA, and Accoutrements
The Federal Aviation Administration (FAA) cares about safety. The gist of what will drive its framework will be operational limitations based on the type of operation you have. And, to be simplistic about it, it carves the universe of business aviation into two groups: for hire (Part 135 of the Federal Aviation Regulations or "FARs") and not for hire (Part 91 of the FARs.
The good news is that if your aircraft is available for hire when you aren't using it, you will retain some advantages. You get to shift the liability onto the shoulders of the manager ("operational control"), you get the income from their marketing, flying, and in some cases you dodge a bevy of sales, use, and related taxes. By way of example, in the great state of Maine, you are deemed an "interstate common carrier"—no different than the tractor-trailers humming up and down I–95. So, you receive great tax treatment. There's no sales or use tax since you are crossing state lines for hire.
When you think of this "gopher hole" initially, it is rather innocuous, and it remains so because many people who become jet owners after due diligence and a careful aircraft acquisition process find themselves in bed with an aircraft manager. This aircraft manager is usually fairly good at doing the basics of keeping costs down and getting income back to the owner. So, life is good, and you can even depreciate the aircraft on your taxes, so long as you smell the correct smell to the IRS, which brings us to the second gopher.
Gopher #2: the IRS and Its Thick Book of Rules
The IRS looks primarily at two dynamics—is this a luxury toy thing that needs more taxation, or is it a vehicle that has some commercial purpose? The promised land for the newly minted aircraft and jet owner is depreciation, and here is where the first gopher interplay leaps up. If the aircraft is operated 100 percent FARs Part 135, then the depreciation becomes passive. Your accountant will tell you whether this is a good or bad thing depending on other types of assets you may own and how that income flows to you.
However, if the aircraft is operated primarily Part 91, then it is a different story, as the owner is now materially participating in the operation of the aircraft. But here's the rub: if you "materially participated in the operation of your aircraft," then you have operational control in the eyes of the FAA when you use your aircraft under Part 91. And, from a risk and liability perspective, you now retain the risk, and it isn't the FAA you'll need to worry about, it's everyone else armed with their lawyers and inspectors.
You'll want to have a solid understanding of your insurance policy and take a look in the mirror to see what steps you've taken to mitigate risk for those flights that are conducted under Part 91.
But let's focus on the good news and how to get more of it. If you don't have other forms of passive income (and things that depreciate from that income), then operate primarily under Part 91 to receive the magical depreciation schedule you were dreaming about when the aircraft sales guy started chirping away about the merits of a new airplane.
This is a very big challenge for the fractional, block charter, and other third-party salespeople since potential owners tend to look deeply into what they are actually getting. If you fly 10, 25, or 50 hours per year, commitment is a hard thing. But, when you fall deeply in love with the candy that is so hard to give up (your own plane, there, ready to go at a moment's notice), your hours tend to climb beyond 100 per year, especially if you are using it both personally and for work.
So, our big dividend and W2 people have hopes for depreciation, but, as is the nature of the game, a gopher shall rear its head as your tax return smile broadens.
Gopher #3: Depreciation versus Operational Control
Our third gopher, liability, presents an interesting, but manageable problem. Consider this situation: you've decided that you're going to operate primarily under Part 91 since your tax adviser confirms this is the way to go. Your manager is an adept Part 135/91 management firm and can operate under 91, yet delivers "better than 135" type risk mitigation. But, your legal adviser reminds you that you need to carefully insure for this type of operation, since there is now a transfer of liability to you for the operation of the aircraft.
The price of admission to the great depreciation club isn't always discussed as it should be. Having operational control isn't the end of the world so long as you act like any responsible Part 91 flight department would—you audit, you oversee, and you make sure that you are in a violation- and risk-free environment—a nice place for anyone, under any circumstances, anyway, right?
Operational control is inherited when you have materially participated in the operation of the aircraft. When it comes to "operational control," you simply "have it." As far as the FAA is concerned, you made the decision to initiate flights even though you are a passenger and most likely not flying the airplane. When you operate privately, or for your own business use exclusively, the owner (who typically knows little about the risks of operations and flying) maintains the operational control. In other words, the owner is liable for the operation of the aircraft.
If you operate under Part 91, the good news s you get the depreciation; the bad news is that you have liability to manage, though it is stuff you'd kind of want to know a lot about in any type of flying you engage in. If you elect going this route, the smartest backstop is to manage the risk by first understanding it. Your motto should be: "We will not hurt this airplane, the people in it, or anyone outside of it." If your aircraft management culture is one that truly internalizes this, you can build a scenario where you are as statistically safe as the airline cousins are, who, for practical purposes, rarely have accidents statistically anymore.
Our recommendation to any Part 91 flight department or private user, family office, trustee, or similar flying arrangement is to subject the aircraft and crew to the highest standard possible of audit, transparency, and best practices on continuous improvement process so that the liability is eliminated to the extent possible. Once you create the culture, your defense is that the only way things ever go wrong is when they are, what the insurance community would term, "acts of God." Better yet, carry enough insurance and really wrap your arms around the insurance policy to understand that eliminating the possibility of FAR violations and good operating practices are the keys to sound sleep.
The Hybrid Hope
Ultimately, most aircraft managers have Part 135 (revenue/for hire/operational control) capability and, when they are properly briefed, managed, and integrated into the family office, your lawyer, risk manager, or advisers can set up your aircraft for being flown under Part 91 or 135 depending on your needs. Better yet, despite the lax safety requirements of Part 91, you can operate the safety standard to the highest level, while you also have the paperwork done properly for the IRS. When doing hybrid operations, it is key to have tax, legal, and operational advisers squarely on the same page.
Private and business aviation is a boon to those who value their time, efficiency, and safety, but lining up the elements before you pull the trigger on aircraft acquisition or management is key for harmonious operations and sane gopher management.
*This article was co-authored by Nel Stubbs and Adam Webster of the Jet Owner Group (www.jetowner.com)
Adam offers a helpful mix of knowledge around aircraft, money and the people that own and operate them. As a lifelong airplane sponge, he can help you sort out just about any problem that involves flying things. Contact him directly via: [email protected]
Nel knows that airplanes are fun. Nothing beats the thrill of ownership, the freedom to go point to point. Better yet, it's good to have the comfort of knowing you just made the smartest jet, helicopter, or turboprop acquisition ever.
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