A SALES AND USE TAX PRIMER: Or, Sales tax 101

In the everyday world of aircraft ownership the following story is played out from coast to coast without stopping to admire the sunrise or the globe fading into the Pacific. The whispers in the crowds of prospective aircraft owners often are based on the age old question, “is it really possible to legally avoid sales tax, or am I risking embarrassment if I get caught trying?” The stress often crashes into the life of the financial personnel to find workable solutions after the boss takes the survey of his friends on the golf course.

The CFO cringes while he is instructed by his boss to make the new deal work by tomorrow morning, and “oh. by the way, I don’t want to waste a nickel on tax.” He inherently knows that no matter how careful he is to explain every minute detail of the strategy to Mr. Big, it is ultimately the owner who will demand that he be able to use his new multi-million dollar toy wherever and however he wants. He will end the meeting by commanding the CFO, “make it work out, I’m sure you can find a way.”

Many buyers listen to the free advice that comes once they first enter the sales cycle. The aircraft sales person who generally works with the belt and suspenders clients often take the most conservative approach and advise against “risky tax schemes.” The wheeler-dealer salesperson, blabs on about the latest trick and pats the back of his new client while he croons, “trust me, it is easy to get out of the tax.”

Neither approach will serve the new aircraft owner very well. The basic problem is that, unlike federal tax advice which is based on a code that applies every where in the United States, sales tax advise depends on the codes written in each separate state. Currently five states have no sales and use tax. However, that leaves forty-five others that will require proper research. Unless you have nothing to do but spend your entire life doing research, it is impossible to keep track of the constant changes state-by-state.

The simple answer to the question is “Yes. It is possible to legally avoid sales/use tax on the purchase of an aircraft.” The complex answer is, “it depends on how much you value the money you save in tax, versus, the work you have to do to legally avoid it.” The basic necessity for all new aircraft owners to answer their question is valid research. Sales tax research must contain a foundation of a basic understanding of the law that will apply in all cases, then must be targeted to focus in on the exact needs of the owner. Every case contains different planned use by the owner, which impacts which states must be assessed. Once the foundation is poured, and the specific states are identified the owner can then do a risk analysis of the available options.

In order to support a claim for an exemption two basic things are required. It is essential that both the form and the substance of the transaction is met. It is not sufficient enough to actually do all the things that the local law requires to exempt your new aircraft because tax law places the burden of proof on the taxpayer. It is paramount that the taxpayer can adequately document the actual possession, storage and use of the aircraft.

The various types of exemptions are as follows;

• Common carrier
• Interstate commerce
• Purchased for out of state use
• Purchase for resale
• Occasional sale
• Out of state buyer
• Lease

Even though each state may have sections that relate to each of the above, you can not presume that the details of the exemption are the same from state to state. For example, the language in certain sections of sales tax law in Nevada may be the exact words used in California, however, each state may interpret the same language differently.

The important details actually depend on how the requirement by each state will impact the needs of the aircraft owner. The basic questions that need to be asked of the new owner on a section by section basis might adhere to the following:

1. Common Carrier Do you really want strangers flying in your new aircraft? Exclusive use may void this exemption. Are you contemplating a lease arrangement with a charter, or are you planning to acquire your own FAA certificate? Are you aware that the documentation requirements and the term of the test period may be significantly greater than most other exemptions?

• Interstate Commerce
  Do you know how your specific state defines “interstate commerce?”
  How do you calculate intrastate flights using this test?
  Where must possession occur?
  How is first use and first functional use defined?
• Purchased for out of state use
  Where must possession occur?
  How is first use and first functional use defined?
  How long is the test period?
  What are the mechanical requirements of the test?
• Purchase for resale
  Can a purchaser of a single item claim this exemption, or must the owner be a registered dealer of aircraft?
  Can any use, other than bonafide demonstration and display be made?
  What are the documentation requirements to support demonstration flights?
  How much use is too much to claim a resale exemption?
  Can a charge be levied for a demonstration flight?
  
• Occasional use
  Is this exemption available in the state the purchaser intends to claim this exemption?
  

What characteristics must the seller avoid, in order for the sale to qualify as an occasional sale?

• Out of state buyer
  Can an out of state buyer avoid sales tax?
  If so what are the requirements?
  

How long can the aircraft remain in state after the purchase before the transaction becomes taxable? What if repairs or training are required?

• Lease
  Is it a lease to a common carrier?
  Is it a lease to a flight school?
  Is it a lease to a private party?
  How is the tax reported?
  

How does the purchaser insure that he can purchase the aircraft ex-tax and pay based on the lease?

• Is the tax assessed on the lessor or the lessee?

Based on my research library the types of failures that are inherent by using the possible exemptions are:

• Common carrier
  Many people believe that merely flying the aircraft in Part 135 qualifies for an exemption.
  When the owner is in control of the aircraft he may be causing a failure of the exemption.
  When the owner leases an aircraft to a charter he puts the control of the documents needed to support the exemption in the hands of another party.
• Interstate commerce
  Failure to keep exact logs
  Failure to document commerce flights.
  Is the test accomplished by miles, flight hours, or days?
• Purchased for out of state use
  Failure to properly document location of the aircraft when title is transferred.
  Failure to keep proper logs
  Failure to document storage location and time.
  Inconsistencies in documentation.
  Failure to support intent.
  
• Purchase for resale
  Making improper use of inventory
  Charging for use
  Personal use
  Documenting demonstration and display
• Occasional sale
  This exemption is not available in all states
  Failing to support the status of the seller
• Out of state buyer
  Failure to prove the legal status of the out of state resident
  In state residency for the purpose of sales tax can require as little as a checking or savings account.
• Lease
  Failure to properly notify the state to be able to purchase ex-tax.
  Failure to understand against whom the tax is levied and how it impacts the aircraft owner.
  Failure to understand whether it is a sales tax or use tax.

When a purchase is of a fractional share of an aircraft it becomes almost impossible to use certain exemptions because of the needs of the other owners. A winning strategy can be implemented, but it requires the compliance of the fractional partnership.

If an aircraft strategy includes a 1031 like kind exchange, each possible exemption needs to be evaluated versus the four transactions required to complete each exchange. Each of the four transactions has it own tax exposure. When a reverse exchange is used, five transactions are created that need to be evaluated. A further complication is that some states will consider the qualified intermediary as a retailer of aircraft because it is engaged in the business of selling aircraft. It is fatal to forget that IRS rulings have no bearing on how each state views each transaction.

Armed with an understanding of the sales and use tax laws it is possible to create a strategy that legally avoids the sales and use tax. Acquiring sales tax advice from anyone, other than a sales tax expert is in most cases a waste of time and money. This area of tax law is too complex, the targets are constantly changing, and the potential tax assessment is very costly. Especially when you add the additional interest and penalties that can range from as little as ten percent for failure to file, up to a fifty percent penalty for registering an aircraft out of state in an attempt to evade tax.

If you have any questions regarding this article, other sales and use tax issues, or want to know if you qualify for an exemption contact Joseph Micallef at (916) 369-1200 or visit us on the web at www.ASTC.com.