Personal Use: Impact on the Company Ruth Wimer - McDermott, Will & Emery Doug Stewart - AircraftLogs Live NBAA Webinar May 29, 2012
Agenda & Objectives Introductions Wimer Fictional Case Study Jackson Power Stewart IRS Entertainment Disallowance Overview of the Entertainment Disallowance Wimer Sample Calculation of Entertainment Disallowance Stewart Strategies for Maximizing Tax Deductions Wimer SEC Proxy Disclosure Requirements Overview of SEC Proxy Requirements Stewart Strategies for Minimizing SEC Proxy Disclosures Wimer Deductibility of Charitable or Lobbying Flights Wimer Questions & Answers 2
Summary Notes Personal Use: Impact on the Company In this session, the group participants will learn the key differences between a personal entertainment flight and a personal, non-entertainment flight. They will learn how the IRS s entertainment disallowance rule reduces a company s annual tax deductions. The participants will also learn about SEC proxy disclosure requirements applicable to personal flights by certain individuals. Armed with a general understanding that certain flights can reduce a company s tax deductions and increase its public disclosures, our presenters will discuss: Calculating the IRS entertainment disallowance and the SEC proxy disclosure amounts Strategies to maximize tax deductions and minimize SEC proxy disclosures Deductibility of flight expenses attributable to charity or lobbying activities 3
Agenda & Objectives Introductions Wimer Fictional Case Study Jackson Power Stewart IRS Entertainment Disallowance Overview of the Entertainment Disallowance Wimer Sample Calculation of Entertainment Disallowance Stewart Strategies for Maximizing Tax Deductions Wimer SEC Proxy Disclosure Requirements Overview of SEC Proxy Requirements Stewart Strategies for Minimizing SEC Proxy Disclosures Wimer Deductibility of Charitable or Lobbying Flights Wimer Questions & Answers 4
Our Case: Jackson Power Industries Electrical Contractor for the Utility Industry Founded by J. Walter Jackson, Chairman & CEO, age 63 Led by J. Walter Jackson Jr., President 4000 employees across the southwestern US Publicly-traded on NASDAQ beginning in 1999 Headquarters in St. Louis 5
Business Aviation Profile Falcon 2000 owned by Jackson Power Industries Based in St. Louis (KSUS) The company s first aircraft Acquired in 2011 for $17 million Four pilots and a scheduler on staff $2 Million Annual Operating Costs Common uses of the aircraft: Transport sales executives and marketing teams Transport project managers to utility work sites Weekly commutes of CEO from his home in Colorado Springs Provide personal transportation to Jackson family 6
A Typical Week Five Trips in October 2011 1. Monday Morning Commute Aircraft flies to Colorado Springs to pick up Jackson Sr. Roughly 4 hours round trip 2. Monday Afternoon Round trip to Pittsburgh (2 VP s) 3. Tuesday Round trip to Atlanta office (2 VP s) 4. Wednesday Round Trip to Chicago (2 Engineers) 5. Thursday Combined Trip to Pittsburgh & Boston Two Sales Reps fly to Pittsburgh Jackson family (family of four) rides along for drop off on Boston (starting a week of vacation) Aircraft returns Pittsburgh, takes the two Sales Reps home 7
Three Areas of Impact to Jackson Power 1. Calculate SIFL Impact for Employees with Personal Use of the Aircraft (covered last week) 2. Calculate Entertainment Use Disallowance Quarterly Calculation of Entertainment Disallowance for Tax Provision (in the corporate financial reporting) Annual Calculation of SIFL for Employee Personal Use Annual Disallowance as part of Corporate Return 3. Disclose Incremental Cost in the Annual Proxy Statement Compensation Disclosures for Named Executive Officers (NEO s) Related party transactions, if applicable 8
Aviation Reporting Can Generate Significant Workload 9
Agenda & Objectives Introductions Wimer Fictional Case Study Jackson Power Stewart IRS Entertainment Disallowance Overview of the Entertainment Disallowance Wimer Sample Calculation of Entertainment Disallowance Stewart Strategies for Maximizing Tax Deductions Wimer SEC Proxy Disclosure Requirements Overview of SEC Proxy Requirements Stewart Strategies for Minimizing SEC Proxy Disclosures Wimer Deductibility of Charitable or Lobbying Flights Wimer Questions & Answers 10
Aircraft Expense Disallowance Summary: American Jobs Creation Act of 2004 ( AJCA ) requires companies to disallow the cost of personal entertainment flights provided to specified individuals. This calculation becomes a percentage of your aircraft use IRS Notice 2005-45 explained how to disallow and severely impacted the deductibility of corporate aircraft. Many companies still unaware and fail to disallow. Often its caused by a process breakdown Critical data never gets from the flight department to the reporting team or tax staff. Preventing a portion of your overall aviation expenses from being deductible on the company tax return Makes the flight department look expensive 11
What Are We Disallowing? Four Methods of Calculation but each deal with occupied seats Before AJCA, only the business purpose of the flight mattered Now, the business purpose of every passenger matters Example: Chairman on business trip, family rides along Before AJCA: 100% deductible No problem After AJCA : spouse & two children 75% is non-deductible Your Data Matters. Your Flight Patterns Matter! Example: $2 Million operating budget and $5 Million of depreciation Disallowing only 30% could cost the company $840,000 (40% of 30% of $7MM) 12
Classification of flights Employer-provided flights Business (B) No SIFL income/expenses are fully deductible B - Business PE Personal Entertainment PNE - Personal Non-entertainment Personal Non-Entertainment (PNE) - Report SIFL income. Expenses are fully deductible. No SIFL income Fully deductible Report SIFL Disallowed Expenses Report SIFL income Fully deductible Personal Entertainment (PE) - Report SIFL income. Expenses not deductible (except for SIFL amount or reimbursements). Calculate Disallowance Percentage: Flight by Flight method Occupied seat method Time sharing agreement 13
Category #1 Business flights Includes only flights that are ordinary and necessary to the company s business A business flight can include business entertainment where the entertainment portion was before during or after business discussions, associated with or related to the taxpayer s business or directly business related 14
Spouse, family and personal guests Spouses: Just say no! Almost never be considered an ordinary and necessary business expense. Taxable fringe benefit to the employee Must consider whether the spouse is traveling for entertainment or non-entertainment purposes. 15
Category #2 Personal non-entertainment Examples of Personal Non-Entertainment Flights not subject to the disallowance Commuting to and from work, or travel between residences Investment activity Director meetings of unrelated company Meetings with broker, attorney, accountant Doctors visits Funerals Charitable activities Children to and from school or visiting colleges 16
Category #3 Entertainment Treasury Regulation 1.274-2(b)(1)(i) generally defines entertainment as any activity which is of a type generally considered to constitute entertainment, amusement or recreation, such as entertaining at night clubs, cocktail lounges, theatres, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacation and similar trips. Objective test shall be used. Examples of entertainment: ALL VACATIONS, weddings and other parties, visiting well relatives such as children in college, and entertainment activities with business associates where not attached to actual business discussions or activities. 17
Expenses All costs of maintaining and operating the aircraft Proposed Regulations: includes, but is not limited to, salaries for pilots, maintenance personnel and other personnel assigned to the aircraft, meal ad lodging expenses of flight personnel, take-off and landing fees, costs for maintenance flights, costs of on-board refreshments, amenities and gifts, hangar fees (at home or away), management fees, costs of fuel, tires, maintenance, insurance, registration, certificate of title, inspection, and depreciation: and all costs paid or incurred for aircraft leased or chartered, to or by the taxpayer. Interest? 18
Employer provided flights allocation of costs Occupied seat method or the flight by flight method Allocate costs based on each passenger s primary purpose for traveling Calculation may be performed in either hours or miles Annual choice between these two methods, and between miles and hours Must use same method for all planes 19
Deadhead Flights Must be Tracked Flight with no passengers Same number of passengers traveling for the same purposes as the occupied flight to which the deadhead flight relates Note that Deadhead must count for the Entertainment Disallowance, but not for income inclusion (SIFL) purposes 20
Specified Individuals Officers, directors and 10 percent owners Spouse, Family and Personal Guests: Such flights are considered provided to the specified individual for purposes of the entertainment disallowance, because of the relationship to the specified individual Officers are defined by reference to securities laws vice presidents in charge of a. Example: Jackson Power considers SVP s and above to be specified individuals No IRS impact unless personal entertainment use occurs less likely to overlook 21
Agenda & Objectives Introductions Wimer Fictional Case Study Jackson Power Stewart IRS Entertainment Disallowance Overview of the Entertainment Disallowance Wimer Sample Calculation of Entertainment Disallowance Stewart Strategies for Maximizing Tax Deductions Wimer SEC Proxy Disclosure Requirements Overview of SEC Proxy Requirements Stewart Strategies for Minimizing SEC Proxy Disclosures Wimer Deductibility of Charitable or Lobbying Flights Wimer Questions & Answers 22
Aircraft Financial Summary Aircraft acquired in 2011 for $17M Direct Operating Costs: $1 million (Fuel, Mx, Engine reserves) Fixed Costs: $1 Million (Salaries, hangar, insurance, etc.) Depreciation will be $5.5 million in 2012 (6 year MACRS, half year) Approx. 400 flight hours per year: 100 hours of personal entertainment use by the CEO, President and their guests 200 hours of business 100 hours of commuting Jackson Power will have about $7.5 million of cost subject to disallowance rules this year 23
Typical Weekly Flight Patterns Monday & Friday Commute of Jackson Sr. Chicago Pittsburgh Boston Colorado Springs St. Louis Frequent Flights to Regional Office Locations Atlanta 24
Review: Five Trips in October 1. Monday Morning Commute Aircraft flies to Colorado Springs to pick up Jackson Sr. Roughly 4 hours round trip 2. Monday Afternoon Round trip to Pittsburgh (2 VP s) 3. Tuesday Round trip to Atlanta office (2 VP s) 4. Wednesday Round Trip to Chicago (2 Engineers) 5. Thursday Combined Trip to Pittsburgh & Boston Two Sales Reps fly to Pittsburgh Jackson family (family of four) rides along for drop off on Boston (starting a week of vacation) Aircraft returns Pittsburgh, takes the two Sales Reps home 25
These Trips will Trigger the Following Monday & Friday Commute of Jackson Sr. Chicago Pittsburgh Boston Colorado Springs St. Louis 1. SIFL Income to Jackson Sr. 2. Disallowance of costs associated with the Boston trip St. Louis Atlanta Frequent Flights to Regional Office Locations 3. SEC disclosure of the incremental cost to the company of providing personal use to Jackson Sr. 26
Occupied Seats Matter Example: Executive on a business trip, spouse & two children ride along for fun Before AJCA: The plane was departing for business No problem After AJCA : spouse & two children 75% is non-deductible Your Data Matters. Your Flight Patterns Matter! Jackson Power has $7.5 million of cost at stake $2 million of departmental costs $5.5 million of depreciation 27
Disallowance Impact to Jackson Power Just a 1% Swing Equals $75,000 Direct Operating Costs: $1,000,000 Fixed Costs: 1,000,000 Depreciation: 5,500,000 SIFL 4,437 Costs Subject to Disallowance $7,495,563 Difference of almost $2 Million between Methods!! Seat Hours: 45.79% or $3.43MM Seat Miles: 40.77% $3.06MM Flight Hours, Flight By Flight: 26.31% $1.97MM Flight Miles, Flight By Flight: 21.82% $1.64MM 28
Seat Hours Weighted Average Calculation 29
Seat Miles Weighted Average Calculation 30
Flight Hours Flight by Flight Calculation 31
Flight Miles Flight by Flight Calculation 32
Comparing the Four Disallowance Methods Small Annual Passenger Volume (~30 or less): Large variations in all four methods may result personal use has a big impact Large Passenger Volume: As the volume of passenger travel increases (100 or more), the results have a tighter dispersion Flight Patterns Matter: If Personal Trips are typically longer than Business Trips, Seat Hours may provide better results (Miles accumulate faster than Hours on long trips) Flight By Flight Method: Often helpful to offset trips with large group of personal travelers 33
Agenda & Objectives Introductions Wimer Fictional Case Study Jackson Power Stewart IRS Entertainment Disallowance Overview of the Entertainment Disallowance Wimer Sample Calculation of Entertainment Disallowance Stewart Strategies for Maximizing Tax Deductions Wimer SEC Proxy Disclosure Requirements Overview of SEC Proxy Requirements Stewart Strategies for Minimizing SEC Proxy Disclosures Wimer Deductibility of Charitable or Lobbying Flights Wimer Questions & Answers 34
Strategies for Maximizing Tax Deductions Substantiate, Substantiate, Substantiate Not substantiating can lead to denial of characterization of flight as a business flight, or a flight as a nonentertainment flight Ensure all flights which will not be disallowed have clear and contemporaneous documentation Calculate deduction disallowance all four ways and pick lowest disallowance year by year Draft and follow policy minimizing permitted personal entertainment use. 35
Strategies (cont d) Analyze all personal flights to ensure proper treatment Attempt to combine business trips and entertainment trips Minimize deadheads for personal entertainment; conversely, be sure to properly include seat hours/miles for business deadheads in your disallowance calculation Multiple Aircraft? Consider the impact of grouping like aircraft together Consider utilizing aircraft with lower tax impact for personal entertainment flights 36
Agenda & Objectives Introductions Wimer Fictional Case Study Jackson Power Stewart IRS Entertainment Disallowance Overview of the Entertainment Disallowance Wimer Sample Calculation of Entertainment Disallowance Stewart Strategies for Maximizing Tax Deductions Wimer SEC Proxy Disclosure Requirements Overview of SEC Proxy Requirements Stewart Strategies for Minimizing SEC Proxy Disclosures Wimer Deductibility of Charitable or Lobbying Flights Wimer Questions & Answers 37
SEC Annual Reporting to Shareholders Proxy Statement: Must Disclose the Value of Aircraft Personal Use for each Named Executive Officer (NEO) Amounts exceeding $10,000 must be disclosed in the company s Summary Compensation Table Amounts exceeding the greater of $25,000 or 10% of total perquisites require separate footnote explanation Generally, included under All Other Compensation Value = Aggregate Incremental Cost (AIC) of Providing the Compensation. Significant variations in calculations across reporting companies. Just one non-business round trip between LAX and Teterboro can trigger SEC reporting requirements. 38
SIFL Income & Proxy Disclosures of AIC SIFL and Proxy disclosures go hand in hand For NEO s, the AIC disclosure is closely related to the flights which require SIFL SIFL can be disclosed for informational purposes, but does not satisfy AIC disclosure requirements The incremental cost is generally much greater than SIFL Sample :Round Trip LAX & TEB Gulfstream G-IV SIFL: $3,941 / person Incremental Cost: ~ $27,000 Retail Charter: ~ $60,000 39
Methods of Computing AIC Summary: Those costs which the company would not have incurred but for the personal use of the plane by an NEO or their guests Significant variations among reporting companies, but some common practices include Exclusion of fixed costs (salaries, depreciation, maintenance) Inclusion of variable costs (fuel, trip-related expenses) Exclusion of flights where business passengers are aboard (negligible incremental cost for personal use passengers) Use of published hourly operating costs Use of actual hourly operating costs 40
Sample of a Proxy: General Electric NEO s AIC Disclosure of Time Sharing Agreement with NEO 41
Sample Footnote (Phillip Morris) The amounts shown are the incremental cost of personal use of Company aircraft to Phillip Morris and include the cost of trip-related crew hotels and meals, in-flight food and beverages, landing and ground handling fees, hourly maintenance contract costs, hangar or aircraft parking costs, fuel costs based on the average annual cost of fuel per hour flown, and other smaller variable costs. Fixed costs that would be incurred in any event to operate Company aircraft (e.g. aircraft purchase costs, depreciation, maintenance not related to personal trips, and flight crew salaries) are not included. 42
Other AIC Disclosure Samples..based on the aggregate incremental cost to the Company using a method that accounts for fuel, maintenance, landing fees, other associated travel costs and charter fees. includes the incremental cost of relocating aircraft to accommodate personal trips and the incremental costs of flights for and to attend outside board meetings for the public companies and government institution at which they serve as outside directors. is determined by multiplying the total 2011 personal flight hours by the incremental aircraft cost per hour. The incremental aircraft cost per hour is derived by adding the annual aircraft maintenance costs, fuel costs, aircraft trip expenses and crew trip expenses, and then dividing by the total annual flight hours. 43
Jackson Power Aggregate Incremental Costs Monday & Friday Commute of Jackson Sr. Chicago Pittsburgh Boston Colorado Springs St. Louis St. Louis Assume $3000/hour (you should track actuals) Frequent Flights to Regional Office Locations 3.9 hours for Monday s commute 4.0 hours between Pitt & Boston Atlanta 7.0 hours x $3,000 = $21,000 this week (vs. $25,000 threshold) (note we have included the deadhead BOS > PIT) 44
Agenda & Objectives Introductions Wimer Fictional Case Study Jackson Power Stewart IRS Entertainment Disallowance Overview of the Entertainment Disallowance Wimer Sample Calculation of Entertainment Disallowance Stewart Strategies for Maximizing Tax Deductions Wimer SEC Proxy Disclosure Requirements Overview of SEC Proxy Requirements Stewart Strategies for Minimizing SEC Proxy Disclosures Wimer Deductibility of Charitable or Lobbying Flights Wimer Questions & Answers 45
Time Share Arrangements Summary: Under Part 91.501(c)(1), a time-sharing agreement allows an aircraft operator to be reimbursed for a limited set of costs for a flight. Two Times Fuel - Corporate flight departments often provide time-sharing arrangements, allowing an executive to reimburse the company for personal use of the aircraft. These arrangements require specific tracking of ten eligible costs on each flight: 1. Fuel, oil, lubricants, and other additives. 2. Travel expenses of the crew 3. Hangar and tie-down costs away from home base) 4. Insurance for a specific flight 5. Landing fees, airport taxes, and similar assessments. 6. Flight-specific customs, foreign permits, and similar fees 7. In-flight food and beverages. 8. Passenger ground transportation. Time-sharing arrangements usually trigger excise tax! 9. Flight planning and weather contract services. 10. An additional charge equal to 100 percent of the expenses listed in item 1 (fuel) 46
Reimbursement Strategies Time Sharing Agreements Reimbursements can approximate net incremental cost, reducing the magnitude of the other compensation disclosure. Requires disclosure of a related party transaction Reimbursement under the Nichols Re-interpretation Full reimbursement under specified circumstances (executive must be on board for personal purposes, spouse/dependents notwithstanding) May require Form 8K filing An emerging trend is for executives to reimburse the company via time sharing agreements. 47
Leads to Related Party Transactions Securities & Exchange Commission (SEC) also requires disclosure of related-party transactions Transactions between the executives & the company Proxy Excerpt below: 48
Executive-Owned Aircraft Summary: Often, a company executive may own the aircraft, and lease it back to his/her employer. Leads to more internal accounting, depending on the nature of the arrangement: Dry leases Time shares Etc. Implications: For both Executive-Owned Aircraft and Time- Sharing Arrangements, the executives involved and the company will need to settle up periodically ( who owes who? ). The data provided by the flight department will directly affect these calculations. Settlements will often occur quarterly, in order to be finalized for SEC reporting purposes 49
Section 162(m) Disallowance for Public Companies IRS guidance on the entertainment disallowance supports the position that the Section 162(m) limitations only apply to the amount included in the executives W-2 for entertainment flights Query: Can the same position be taken for nonentertainment flights? 50
Agenda & Objectives Introductions Wimer Fictional Case Study Jackson Power Stewart IRS Entertainment Disallowance Overview of the Entertainment Disallowance Wimer Sample Calculation of Entertainment Disallowance Stewart Strategies for Maximizing Tax Deductions Wimer SEC Proxy Disclosure Requirements Overview of SEC Proxy Requirements Stewart Strategies for Minimizing SEC Proxy Disclosures Wimer Deductibility of Charitable or Lobbying Flights Wimer Questions & Answers 51
Deductibility: Charitable & Lobbying Flights Only out of pockets for charitable flights are deductible Lobbying Flights are not deductible pursuant to section 162(e) which applies to certain lobbying expenses A solution is to SIFL the passenger, and then the remainder is deductible in some instances. 52
Questions for Today s Presenters? RWimer@mwe.com Doug.Stewart@AircraftLogs.com