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Guest Article

Deloitte logo

(From the January 16, 2007 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

162(m) Limitation on Deductions for Entertainment Use of Business Aircraft


Taxpayers are faced with conflicting guidance on whether deductions for entertainment use of a company's aircraft are subject to the Internal Revenue Code § 162(m) limitation on deductions for certain excessive employee remuneration.

Section 274(e), effective for expenses incurred after October 22, 2004, provides that unreimbursed company expenses related to entertainment use by specified individuals is disallowed to the extent that the expenses exceed the amount treated as compensation to specified individuals. Therefore, a taxpayer's deduction for entertainment use by specified individuals is allowed to the extent that the expenses are treated by the taxpayer as compensation to an employee and as wages to such employee.

The treatment of deductions with respect to non-cash fringe benefits for specified employees is also addressed in IRC § 162(m). Section 162(m) limits the deduction for compensation paid by public companies for non-performance based compensation to $1 million a year for "covered employees." The term "covered employees" refers to the chief executive officer and the four highest compensated officers for the taxable year.

Temporary regulations under IRC § 162 originally issued in January of 1985 and subsequently amended in December 1985, December 1989, and December 1992, address the treatment of deductions with respect to non-cash fringe benefits. "If an employer included the value of a noncash fringe benefit in an employee's gross income, the employer may not deduct this amount as compensation for services, but rather may deduct only the costs incurred by the employer in providing the benefit to the employee." Temp. Treas. Reg. § 1.162-25T(a). According to these regulations an amount would not be deductible as compensation and arguably not subject to the limit of IRC § 162(m).

However, the IRS released interim guidance on IRC § 274(e) in the form of Notice 2005-45 ("Notice") in June of 2005. The Notice provides that "[a]ny amount for the entertainment use of an aircraft that is treated by the taxpayer as compensation to a specified individual who is also a 'covered employee' (as defined in IRC § 162(m)(3)) is subject to IRC § 162(m). Thus, to the extent the covered employee's 'applicable employee remuneration' (as defined in IRC § 162(m)(4)), including remuneration related to entertainment, exceeds $1,000,000, the taxpayer's deduction is disallowed under IRC § 162(m)." The Notice is effective for expenses incurred after June 30, 2005 and until regulations are effective. Thus, the IRS' position, confirmed through informal discussions, is that IRC § 162(m) limits deductions associated with imputed income for non-cash fringe benefits, notwithstanding the regulatory language.

With all of the available guidance taken into consideration, taxpayers can rely on the temporary regulations and deduct costs associated with the personal entertainment use of corporate aircraft up to the amount included in the specified individuals' income even if the $1 million deduction limit has been reached for the employee. This is most beneficial if the employer has decided to include the fair market value of the personal entertainment use in the employee's income, rather than use the SIFL rates. Alternatively, the taxpayer could follow the Notice and disallow costs associated with the imputed income to the extent the covered employee's remuneration exceeds $1 million. Using this approach it would be more beneficial to impute only the SIFL amount.

The taxpayer should consider evaluating its policy on entertainment use of a corporate aircraft to see if it can be designed to meet the performance-based exception to IRC § 162(m) to avoid a lost deduction. Performance-based compensation is excluded from calculating the allowable deduction if the performance goals are determined by a compensation committee consisting of at least two outside directors, the material terms of the arrangement are disclosed to shareholders, and before payment is made, the arrangement is approved by a majority vote of shareholders and the compensation committee confirms the performance goals were achieved.

Taxpayers that currently sponsor plans that provide for awards of performance-based compensation intended to comply with IRC § 162(m) may be able to make changes to the plans to provide benefits in cash or in-kind (e.g., entertainment use of corporate aircraft). Depending on the terms of the plan, it may be necessary to amend the plan to provide for in-kind payments.

Some would argue this change would not be a material amendment for purposes of IRC § 162(m), and therefore would not have to be disclosed to shareholders. The taxpayer's legal counsel should determine if providing for non-cash payments (if necessary under the terms of the plan) would be considered material changes requiring shareholder disclosure under the Securities Exchange Commission or stock exchange rules. Aircraft use could then be included as qualified performance based compensation by increasing the annual maximum bonus payable under the plan with part of the increase to be imputed income based on entertainment use of the aircraft for future years.


Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2007, Deloitte.


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