Tax treatment of private jet expenses

TAX TREATMENT OF PRIVATE JET EXPENSES

Facts:
Alex Jones owns a small software company, Find Donuts, Inc in Michigan. A patent on a smartphone application named Find Donuts which is designed to locate donuts shops, is the only asset of Find Donuts, Inc. With the intention of promoting the sales of the Find Donuts smartphone app and increasing company revenue, Alex Jones attended a computer conference in June 2010, in San Francisco.

Alex also owns a Christmas tree farm in Oregon. Primary purpose of this farm being profit but not leisure, it qualifies as a business to be reported in Schedule C of Alex’s federal income tax return. In December 2010, Alex paid a visit to this farm to oversee the sales of trees.

In July 2010, Alex flew to Honolulu, Hawaii to supervise the construction of two additional bedrooms to a house he owns there. He leases this house to a couple, and they operate the house as bed and breakfast (B&B). Those two newly constructed bedrooms were an addition to their B&B.

For the above trips he made to San Francisco, Oregon and Hawaii in 2010, Alex used his Lear jet that he purchased in 2000 for 1 million. Each trip cost him $ 100,000.

Issues:
Does the operational cost for Alex Jones’ jet for the above three trips qualify to be deducted as a necessary or ordinary business expense incurred in conducting a trade or business under IRC Sec. 162?

Conclusions:
Alex Jones’s expense of $300,000 made in using his Lear jet to travel to three destinations in the 2010 tax year may not qualify to be deducted as a necessary and ordinary business expense. Further evidence may be required to determine the necessity and ordinance in each case.

Legal Support:
IRC Sec. 162
Treas. Reg. 1.162-2(a)
Com. v. Lincoln Electric Co., (1949, CA6) 38 AFTR 411, 176 F2d 815.
Kurzet v. Comm., 86 AFTR, 2d 5655.
IRC Sec. 183
IRC Sec. 212
John J. Ballard, TCM 662 (1984).

Analysis:
IRC Sec. 162 allows the deduction of all ordinary and necessary expenses incurred in conducting any trade or business including travelling expenses (other than lavish or extravagant) while away from home for business/trade purposes. Under Treas. Reg. 1.162-2(a), only such traveling expenses as are reasonable and necessary in the conduct of the taxpayer’s business and directly attributable to it may be deducted.

Alex Jones owns a software company that engages in providing a smartphone application to its customers, with a primary motivation of making profit. IRC Sec. 162 may allow Alex Jones to deduct the entire operational cost of $300,000 for the three trips he made in his Lear jet, provided that these expenses are ordinary and necessary. Although IRC Sec. 162 does not enforce a “reasonableness” requirement for business expenses deductions, several courts have held that expenses must also be reasonable in amount as in Com. v. Lincoln Electric Co, and reasonable in relation to its purpose. Also the tax court has stated that reasonableness can be a demonstration that the expense did not exceed the income earned or expected from the activity. The question whether the operational cost for Alex Jones’s jet qualifies to be deducted as a necessary or ordinary and reasonable business expense incurred in conducting a trade or business depends upon the justification of those expenses to be so.

At least a couple of interpretations can be made for each expense incurred. The cost of attending the conference in San Francisco is clearly a business purpose, which is to promote the sales of the smartphone application and also which is ordinary, necessary and reasonable in relation to its purpose. But it is questionable as whether the expense of $100,000 is reasonable in amount in relation to the benefit this trip made to the income because this expense can be considered lavish and extravagant. It is necessary to prove what benefits were gained to the income compared to the expense made. Kurzet v. Comm., 86 AFTR, 2d 5655 clearly proves that the time-saving associated with the use of a private Lear jet than using a commercial air-liner to travel makes the expense in concern reasonable. Kurzet., 86 AFTR, 2d 5655 case is quite similar to Alex Jones’s situation except that taxpayers in Kurzet., 86 AFTR, 2d 5655 made 74 trips which saved them 888 hours of travel time and effort which makes the deduction ordinary, necessary and reasonable in the long run compared to one trip which Alex Jones made to California saving only few hours of his time. It is apparent that it was lavish and extravagant to use the jet to travel when Alex Jones could have used a commercial airliner. Even though there is yet no substantial authority to support for a deduction for Alex Jones’s use of his Lear jet to travel to the computer conference in San Francisco, further evidence to prove the benefits this trip made may support the deduction as ordinary, necessary and reasonable.

The fact that Alex Jones reports the income from his Christmas tree farm in Oregon in Schedule C of his individual federal income tax return proves that it is a sole proprietorship business carried out with a profit motive. Therefore the expense for the Lear jet to visit the farm to oversee sales qualifies as an ordinary (customary or usual within the experience of the timber trade) business expense, but it is required to determine its necessity. It is questionable whether it was really necessary to visit the farm to oversee the sales, instead Alex Jones would have found other means of communication. Even if the visit was necessary, as in the previous case the expense of $100,000 would be lavish and extravagant because the inconvenience associated with normal commercial air travel would be minimal, ordinary and common for Alex Jones as well as businessmen.

IRC Sec. 183 mentions that in the case of an activity engaged in by an individual or an S corporation, if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed. The house in Honolulu is a rental property and there can be concluded that Alex Jones held that property for profit unlike in Kurzet., 86 AFTR, 2d 5655 in which the taxpayers owned the property at Tahiti but did not rent it. IRC Sec. 212 allows an individual to deduct all the ordinary and necessary expenses incurred for the management, conservation, or maintenance of property held for the production of income as in John J. Ballard, TCM 1984-662., but not for the improvement of the property. Improvement of this rental property finds to constitute an addition two bedrooms to the rental property. Thus, the travel expense associated with the improvement of the rental property is clearly not deductible and has no substantial authority to support.

Given the reasoning as mentioned above there are no substantial authority supports for the $300,000 expense Alex Jones made in using his Lear jet for travelling to San Francisco, Oregon and Hawaii in the 2010 taxable year.