Expenses

Hurricane GO Zones: An Update on Relevant Tax Provisions

The widespread devastation left in the wake of hurricanes has resulted in numerous tax provisions aimed at revitalizing and rebuilding the affected areas. Congress passed the Gulf Opportunity Zone Act of 2005, P.L. 109-135 (the GO Zone Act), in response to Hurricane Katrina and then revised it as Hurricanes Rita and Wilma wreaked havoc on the already battered Gulf Coast. Two years after its passage, the GO Zone Act is still relevant, notably the provisions relating to business property and issues such as involuntary conversion rules, nonrecognition of gain principles, and depreciation.

One of the most significant changes to current tax laws is in the area of involuntary conversions. Congress in-creased the time to acquire or construct replacement property from two to five years for anyone located within the Hurricane Katrina disaster area (Katrina Emergency Tax Relief Act of 2005, P.L. 109-73, Section 405). The five-year period begins from the date a taxpayer first receives insurance proceeds, not when the full amount is received. Should a taxpayer need additional time—for example, if the receipt of all proceeds is crucial to purchasing replacement property—he or she may file an application for extension with the IRS with an explanation as to why additional time is needed. A taxpayer may acquire replacement property anywhere within the Hurricane Katrina disaster area. It is not limited to the same location where the damage occurred in order to avoid gain recognition on the conversion. For a complete listing of counties and parishes located in the Katrina, Rita, and Wilma GO Zones, see IRS Publication 4492, Information for Taxpayers Affected by Hurricanes Katrina, Rita, and Wilma.

As with any property that has been involuntarily converted, the taxpayer does not have to recognize a gain if the proceeds are used to purchase qualified replacement property. This provision encompasses both partially and completely destroyed property. Special consideration should be given to having adequate records of the items destroyed. The IRS has allowed separate property to be treated differently when applying the nonrecognition rules. This may be helpful when determining if any gain or loss should be recognized on the property. Involuntary conversion and nonrecognition of gain rules generally apply to qualified GO Zone property, with a few notable exceptions. First, if an uncompensated Sec. 1231 loss occurs, Congress has allowed the loss to be eligible for a five-year carryback period (Sec. 1400N(k)). The taxpayer must be able to establish that the property meets the requirements of Sec. 165, and the involuntary conversion must be a result of Hurricane Katrina. Second, a taxpayer is allowed to purchase any tangible business property in order to avoid recognizing gain. Under normal circumstances, a taxpayer would be required to purchase similar or related property.

Not only can a taxpayer avoid having to recognize a gain on the property, but additional incentives exist for placing new property into service in the GO Zone. First, Congress allowed an extension of the 50% bonus depreciation on qualified property placed in service in a GO Zone (Sec. 168(k)). To qualify, property must have been acquired on or after August 28, 2005, and placed in service before January 1, 2008; for nonresidential real property and residential rental property, the placed-in-service deadline is extended to January 1, 2009 (Sec. 1400N(d)(2)

(A)(v)). It is important to note that if a contract was entered into before August 28, 2005, the property will not qualify. Although specific dates are not listed in all subsections of the GO Zone Act, a general guideline would be to replace August 28, 2005, with September 23, 2005, for the Rita GO Zone and October 23, 2005, for the Wilma GO Zone.

As always, there are exceptions to these rules:

In addition to federal exceptions, state exceptions may also apply because each state applies federal provisions differently. The practitioner should check for GO Zone Act conformity by states outside of the GO Zone. Within the GO Zone, Alabama, Louisiana, and Mississippi differ in provisions to which they conform. None of the states recognizes the federal change in the NOL carryback period in the Hurricane Katrina disaster area. Mississippi does not adopt the 50% bonus depreciation provision, but Alabama and Louisiana both follow federal tax treatment. Alabama, Louisiana, and Mississippi adopted the election to deduct 50% of the cleanup and demolition costs for state purposes. In addition, the individual states may have specific relief or incentive provisions that are not tied to federal rules. Louisiana, for example, may allow additions to the federal in-come tax deduction for federal taxes that were reduced by specific tax credits related to the disasters.

Conclusion

The GO Zone Act provided several tax provisions for business property that are still of note today, including those related to involuntary conversions, nonrecognition of gain, and increased depreciation. Each of these items should be monitored because they may have significant effects on taxpayers, especially those doing business within the GO Zone. Now is the time to be aware of them, because many of the provisions expire at the end of the 2007 tax year.

From Eddie Goldsberry, CPA, Dawn Hodges, and Daniel Travis, CPA, PKF Texas, Houston, TX

New Prop. Regs. Clarify Tax Deductible Entertainment Use of Private Aircraft

The use of private aircraft eliminates the inconvenience of commercial flights, but clients do not normally call their CPAs in midflight to inquire about the tax ramifications of taking a detour with the family on the company jet to visit Aunt Margaret. Nevertheless, it is up to CPAs to sort it out and offer some planning tips to maximize the allowable tax deductions. New proposed regulations under Sec. 274 clarify old rules, introduce new ones, and require additional guidance on some of their applications.

In the American Jobs Creation Act of 2004, P.L. 108-357 (AJCA), Congress overturned Sutherland Lumber-Southwest Inc., 114 TC 197 (2000), aff’d, 255 F3d 495 (8th Cir. 2001), by enacting Sec. 274(e)(2)(B). In Sutherland, the Tax Court held that a company’s tax deduction in connection with the personal use of a company’s aircraft was not limited to the amounts included as fringe benefits in the compensation of passenger employees. Congress saw this as a tax shelter because the total costs deducted by employers were far in excess of the fringe benefits included in income. Congress therefore limited the deductibility of personal entertainment use by those with control over entity costs (referred to as “specified individuals”) to the amounts included in such persons’ income or to the amounts of reimbursement.

Specified individuals include officers, directors, more-than-10% owners, 10% shareholders, 10% equity partners/members, and managing partners/members of a partnership/LLC. In addition, specified individuals do not have to be employees of the aircraft owner if the owner is related to the employer under Secs. 267(b) or 707(b). Both Notice 2005-45 and Prop. Regs. Sec. 1.274-9(b)(6) indicate that use of an airplane by family members or by other persons flying due to a relationship with specified individuals is attributable to the specified individual.

The IRS initially provided temporary guidance in Notice 2005-45 on the limitation computation. On June 15, 2007, the Service issued Prop. Regs. Secs. 1.274-9 and 1.274-10 and amended Prop. Regs. Sec. 1.61-21 to clarify the limitation’s scope and the available computation options (REG-147171-05). The proposed regulations are not effective until they are finalized; however, taxpayers may rely on them before that time. In addition, until the proposed regulations are finalized, taxpayers may rely on either the proposed regulations or Notice 2005-45 if they contain different rules on a particular issue. However, if a rule in the proposed regulations is not included in Notice 2005-45, taxpayers cannot rely on the absence of the rule in Notice 2005-45 to apply a rule contrary to the proposed regulations.

The post-AJCA law disallows all variable and fixed aircraft operating costs (including depreciation and Sec. 179 deduction) allocated to a specified individual’s entertainment use to the extent such costs exceed the amount included as compensation or the amount of reimbursement received from the specified individual.

The methods of cost allocation under Notice 2005-45 (and Prop. Regs. Sec. 1.274-10(e)(2)) are based on occupied seat hours or occupied seat miles (defined as the total hours or total miles flown by passengers multiplied by the number of occupied passenger seats). The total aircraft operating costs for the tax year are then divided by occupied seat hours or occupied seat miles to arrive at cost per occupied seat hour or occupied seat mile. Prop. Regs. Sec. 1.274-10(e)(3) introduces another basis for allocation: the flight-by-flight method. This method divides the total aircraft operating costs for the tax year by the number of flight hours or flight miles for the year to determine cost per hour or cost per mile, and each flight is allocated cost based on its miles or hours. The cost per flight is then allocated to its passengers on a per capita basis.

One should note that the pilot’s seat (and apparently the co-pilot’s seat) does not count as a passenger seat under any of the allocation methods. Maintenance round-trip flights without passengers should also not be included. It remains unanswered whether a pilot and co-pilot (if required) flying as specified individuals without passengers for entertainment purposes would be deemed to be passengers.

Notice 2005-45 and Prop. Regs. Sec. 1.274-10(f)(3) also provide guidance on the treatment of empty flights to pick up passengers or empty return flights after dropping off passengers (deadhead flights). Under both the notice and the proposed regulations, deadhead flights are deemed taken with the same number of passengers aboard and for the same purposes as the occupied flight.

Some other clarifications under the proposed regulations are:

Planning Strategies

Based on the existing temporary guidance, the following strategies will maximize the deductibility of a private aircraft’s operating costs for income tax purposes:

In addition, since the personal or entertainment use provided to em-ployees (or independent contractors) who are not specified individuals is not limited, rewarding a high-performing employee who is not an officer or director with a trip on the private jet (and including the value of the trip in his or her compensation) will increase the numerator of the allowed occupied seat hours or miles, or the allowed per capita flight miles or hours, and thereby the total deductible expenses for the year. Such a strategy, however, could be challenged if the IRS broadly interprets the definition of persons flying “by virtue of a relationship with a specified individual” to include employees. It seems that if Congress intended to include employees in the definition of specified individuals, the Code itself would have reflected such intent. The final regulations should clarify whether employees and independent contractors with a business relationship with specified individuals are excluded from the above definition.

Conclusion

While the Service’s temporary guidance is helpful, additional clarification is needed as noted in this item. Despite the ambiguities, it appears that with some planning, the bulk of aircraft operating costs can be deductible.

From Ora Pressey, CPA, Darcia Stebbens, CPA, and Jim Koopmans, CPA, Damitz, Brooks, Nightingale, Turner & Morrisset, Santa Barbara, CA

Back
© 2007 AICPA