Taxability of Flights on State Aircraft

by Marianna G. Dyson, Esq.

Marianna G. Dyson is the chair of the executive committee of Miller & Chevalier Chartered; she practices in the areas of employment tax and fringe benefits with a focus on consulting, tax audits and appeals controversies involving noncash fringe benefits, employment taxes and accountable plans. She also is a member of the Editorial Advisory Board that serves the Guide.

Twenty-plus years after the statutory overhaul of the tax rules applicable to fringe benefits and the issuance of the related final regulations, state and local government executives still express surprise when informed that their use of employer-provided transportation for personal purposes may give rise to additional wages. Their surprise, which can often be described as shock or outrage, appears to be grounded in the belief that the chief executive of a government entity is always on duty and therefore all travel is for business purposes. That argument is flawed.

Take it as fact. Regardless of the employer’s status as a government, tax-exempt, or taxable entity, the tax rules applicable to an employee’s use of his or her employer’s aircraft or vehicle are essentially the same, with two
notable exceptions:

1. Government and tax-exempt entities do not have to worry about the recently enacted deduction disallowance rule applicable to entertainment flights provided to certain executives (that is, “specified individuals”) of taxable entities; and
2. A more favorable valuation rule (for instance, $1.50 per one-way trip) applies to government employees required to use a government-provided vehicle for personal purposes while covered by an overall security program due to a “bona fide business oriented security concern.”

Over the years, scrutiny of public officials’ use of government transportation for personal purposes has produced press reports involving a White House chief of staff, a sitting governor and a then-current director of the FBI. A recent analysis by the Associated Press (AP) of the use of South Carolina’s aircraft by Gov. Mark Sanford (R) and his family was preceded by a 2007 AP investigation of Illinois Gov. Rod Blagojevich’s (D) similar use of his state’s aircraft, before his impeachment and subsequent removal from office. Both investigations revealed that the governors had used state aircraft frequently for personal purposes, but that no additional income had been imputed either for their individual personal flights or those of family members or guests. The overall tone of the governors’ responses through their respective spokespersons was that no income imputation is required in the case of a sitting governor, based on the following logic:

• the governor is always on duty, therefore flights on state aircraft are characterized as “official” flights and, as such, are deemed to be business use under the Internal Revenue Code and qualify for tax-free treatment under the working condition fringe benefit exclusion;
• the governor receives 24-hour protection, therefore all transportation provided by the state should be deemed to be business travel;
• the governor’s spouse serves as first lady of the state; therefore all of her flights are business flights that should be treated as working condition fringe benefits; and
• the additional costs associated with flights of family members and guests when the governor is on-board are minimal and therefore no additional value for those personal flights must be included in his income.

The tale of the two governors deviates in two respects, however. In taking the offensive, Sanford, through a spokesman, labeled the AP’s investigation a politically motivated “witch hunt” and asserted that “[i]f the AP’s allegations were true, then the IRS would have enforced this law for years on every governor, state legislator, town councilman and elected official across the nation, including members of Congress and even the president.”

Although erroneous in his assertions that the IRS has not enforced the fringe benefit rules with respect to public officials, the governor has an interesting point. There is no specific tax code exclusion applicable to the president’s or his family’s personal use of employer-provided transportation! In spite of this drafting oversight and the IRS’ implicit decision to refrain from pointing out that “the emperor wears no clothes,” Sanford’s observation is irrelevant when analyzing the proper tax treatment of fringe benefits provided by his employer — the state of South Carolina. He is subject to the same rules as other executives of public or private entities. In other words, the value of personal flights on state aircraft provided to him, his family and guests must generally be included in his income and treated as wages for payroll tax purposes.

In contrast, Blagojevich’s advisers decided not to point out the enforcement anomaly that exists with respect to the leader of his political party. Eventually, the dialogue that his advisers had with the press focused instead on the governor’s “tax home.” A taxpayer may have only one tax home under federal tax law, which generally is his or her principal place of business. Travel to temporary places of work from one’s tax home may qualify as business trips and be treated as a working condition fringe benefit if provided by an employer.

In Blagojevich’s case, many of his flights on the state’s aircraft were between Chicago, where he maintained his personal residence, and Springfield, the state capital. Even though the Illinois constitution requires the governor to maintain a residence in Springfield — a requirement that could be interpreted as deeming Springfield to be the governor’s tax home — Gov. Blagojevich maintained offices at the state’s government center in Chicago and spent more time working there than in his offices in Springfield. In other words, a determination based on the facts that the Blagojevich’s tax home was Chicago could support an argument that his flights between Chicago and Springfield (a regular place of business) were not personal (commuting) trips, but instead were business trips.

At a minimum, both AP investigations offer a perfect opportunity to remind public officials — and, more importantly, their government employers — of the fringe benefit rules and the consequences of failing to respect them. A failure to treat a taxable fringe benefit as additional wages creates not only potential audit exposure for unpaid taxes on the public official’s unreported income, but also potential exposure for a retroactive assessment of payroll taxes against the employer under the principle of secondary liability, when the failure is identified during an employment tax examination.  These risks can be eliminated by the employer’s insistence that business use of a vehicle or aircraft be timely substantiated and that personal use be valued for inclusion in the employee’s wages.

As background, the value of the noncash fringe benefit (for example, a flight on the employer’s aircraft or use of the employer’s car) is presumed to be income under the Internal Revenue Code, unless a statutory or regulatory exemption applies. For example, the exclusion for working condition fringe benefits is designed to exclude the value of benefits provided to current service providers, when the expenses for providing the benefit (1) relate to the employer’s business, (2) would have been deductible by the employee had he or she paid for them, and (3) are adequately and timely substantiated. If the business expenses are not adequately substantiated — such as is the case when an employee fails to substantiate the business reasons for using employer-provided transportation — the entire value of the employee’s use of the benefit must be treated as personal use and included in his or her wages.

In the case of Govs. Sanford and Blagojevich, aircraft logs were kept of each trip, but the business purpose of each flight may not have been contemporaneously kept in conformity with IRS regulations. This recordkeeping deficiency exposes each employer to additional wages for flights that may, in fact, have been business flights.

Next, it is important to remember that the employer’s cost of providing a fringe benefit is generally irrelevant for income imputation purposes. If a noncash fringe benefit is not excludable from the employee’s income, the fair market value of the benefit must be treated as wages, not the benefit’s cost. Special valuation rules, however, apply to certain commonly provided fringe benefits, such as vehicles and aircraft.

In the case of aircraft, the special noncommercial flight valuation rule — known as the Standard Industry Fare Level (SIFL) rule — applies to provide more favorable valuation than charter value for income inclusion purposes if the rule is properly elected by the employer. In the governors’ cases, the payroll tax savings on personal flights valued for income inclusion purposes by applying the SIFL calculation would have been considerable. But the failure of each state to apply SIFL valuation at the time the personal flights were provided to the governor, his family and guests could permit the IRS to assess payroll taxes based on charter valuation during an employment tax examination.

Critically, the fringe benefit rules require the employer to determine why each passenger is on the aircraft and, in situations in which a family member or guest is flying for personal purposes, to determine the value of each individual’s flight so the value of those flights can be included in the income of the employee who invited him or her. The fact that the primary purpose of the aircraft’s flight is for business reasons does not convert all the other passengers’ flights into business flights.

For example, even if the governor is traveling on business, the value of any flight attributable to a family member or guest must be imputed to the governor if the family member or guest is not traveling for the state’s business (and less than 50 percent of the regular seats on the aircraft are not occupied by passengers traveling on state business). In this regard, the spouse of the governor is not deemed to be traveling for business unless he or she can demonstrate the business purpose of the flight. This standard generally requires that the governor’s spouse perform significant services for the state in conjunction with the flight.

Moreover, it appears to be a common misconception that if the public official receives protection because of a “bona fide business-oriented security concern,” an otherwise personal flight is converted into a business flight. That is not the case. If the public official is the subject of an “overall security program” as defined by the regulations, an additional special valuation rule may apply to his flights or those of his family, resulting in less income for the personal flights. However, the flights still retain the character of personal flights.

What’s a Public-sector Employer To Do?

Like private employers, a government entity should establish policies setting forth the conditions under which fringe benefits, particularly flights on aircraft and use of vehicles, will be provided to public officials. The policies should explain the requirements for proving the business use of transportation, including the recordkeeping rules, so the employer can exclude the value of any business use from the employee’s income and properly treat the personal use as additional wages using any applicable special valuation rules.

More information about employee use of employer-owned aircraft can be found in the Employer's Guide to Fringe Benefits.