Practical Tips for Regulatory Compliance with a Company Jet

About the Authors:

Michelle M. Wade is a partner with the law firm of Jackson & Wade, L.L.C. and counsels clients on the acquisition, registration, financing, and operation of corporate jets operated under Part 91 and Part 135 of the Federal Aviation Regulations. She can be reached at mwade@jetlaw.com.

Overview

If your client owns or operates or plans to purchase a business aircraft, it is important to understand that aviation is a highly regulated industry where the requirements of various government agencies are often at odds with each other and with certain of the client’s goals. This article outlines basic ownership and operating options available to aircraft owners, and common pitfalls to avoid when selecting and implementing these options, to help your client achieve regulatory compliance.

Step-by-Step Action Plan

The first step in achieving regulatory compliance for your client is to become aware of the range of potential regulatory issues. At the federal level, the FAA, DOT, IRS, FEC, and SEC all have regulations affecting aircraft. There are also state property tax and sales/use tax issues that can significantly affect owning and operating an aircraft. If the aircraft flies internationally, there are foreign regulations and tax issues to be considered. In addition, insurance must be considered. Although an insurance policy is not a regulation, it is important from a risk-management perspective to ensure that the aircraft operations comply with the insurance application and insurance policy.

Identifying your team is the next step in achieving regulatory compliance for your client. When creating your team, consider including the flight department/pilot, regular legal counsel (in house or outside counsel), experienced outside aviation counsel, a tax advisor, a risk department/insurance agent, and the principal or his or her direct representative. The flight department knows the aircraft’s operations, but does not necessarily know the federal tax issues that can affect how the aircraft is owned or operated. The tax advisor will understand the pertinent tax issues, but generally is not aware of conflict areas between the tax and aviation regulations. If the flight department or the tax advisor alone plans the ownership and operation of the aircraft, regulatory requirements are easily and inadvertently violated. Given that facts change, a review of the aircraft operations every few years is necessary to maintain regulatory compliance. A good team will enhance your ability to achieve and maintain regulatory compliance.

Your team’s next steps are to gather facts and to prioritize the ownership and operational goals. Important facts include the passengers who fly on the aircraft, for what purpose each passenger flies, and for which business entity each passenger flies. Priorities of ownership and operational goals include compliance with U.S. federal aviation regulations (commonly referred to as the Federal Aviation Regulations or FARs), the maximization of tax deductions, and the minimization of risk.

Decisions—Ownership and Registration

The FARs will affect which entity or individual will own and register the aircraft. To validly register an aircraft under its own name, an entity or individual must meet the FAA’s definition of “citizen of the United States” provided at 49 U.S.C. § 40102. Although the definition is short, determining who is and who is not a citizen of the United States is not always as easy as it appears. For example, the FAA considers a partnership to be eligible to register an aircraft in the partnership’s name only if each partner is an individual who is a citizen of the United States; therefore, a partnership that has a corporate general partner is ineligible to register an aircraft in its name.

For a corporation or a limited liability company to qualify as a citizen of the United States, the president, at least two-thirds of the board of directors, and at least two-thirds of the other managing officers must be citizens of the United States. If a non-U.S. citizen becomes president of a corporation or LLC, that entity will no longer be in regulatory compliance, and the aircraft’s registration will be immediately invalidated. The entity must also be under the actual control of U.S. citizens, and at least 75 percent of the voting interest must be owned or controlled by U.S. citizens. It is not uncommon for a non-U.S. citizen investor to acquire more than 25 percent of the voting interest without anyone considering the invalidating effect of this action on the aircraft’s registration.

Fortunately, regulatory compliance with registration of the aircraft is achievable if the client does not meet the FAA’s definition of “citizen of the United States”. Options for registering the aircraft with the FAA include owner trusts, voting trusts, and registration as an aircraft “based and primarily used” (BAPU) in the United States. An owner trust requires the aircraft to be placed into a trust and registered in the name of the trustee. The client will have physical control of the aircraft and will not be required to obtain approval from the trustee for each flight. A voting trust requires that the shares of the entity be held in a trust and, under the more restrictive BAPU registration, that the FAA receive reports every six months that at least 60 percent of the total flight hours were within the United States. The BAPU option is not available to LLCs, and there is no regulatory cure period if at the end of the six months the 60-percent requirement is not satisfied. If the requirements are not met, the aircraft’s registration is invalidated.

Decisions—Operations

Now that your team has considered some of the regulatory issues surrounding aircraft ownership and registration, your team must review the regulatory issues surrounding the aircraft’s use. Will the owner be the sole operator of the aircraft? Will the owner lease the aircraft? Will the owner and various lessees operate the aircraft? Another decision involves where the flight crew will be employed. Although these decisions are frequently treated as afterthoughts, they are essential to achieve compliant aircraft operations.

A common operational problem is a sole-purpose entity (SPE) that owns the aircraft, employs the flight crew and provide flights to other entities and individuals.  If the SPE meets the FAA’s definition of “citizen of the United States” the SPE can own the aircraft, however the FAA does not permit an SPE to provide flights to other entities or individuals.  Many SPEs are organized to try to limit liability related to the operation of the aircraft.  SPEs that operate aircraft violate the FARs, likely violate the insurance policy, and can inadvertently create additional risk.

If you identify an SPE operating an aircraft, action should be taken to remedy the violation and change the operation of the aircraft to meet the regulatory requirements. There are several options available, depending on the goals and priorities of the parties and the relationship of the various users. For example, the SPE may lease the aircraft to the individual or entity that is actually using the aircraft on business or personal trips, provided that the flight crew is obtained from an independent source. Alternatively, the SPE can lease the aircraft to a charter company that can then charter the aircraft to the various users.

Whether to operate the aircraft under the FAR Part 91 regulations or the FAR Part 135 regulations is an important decision to make during the regulatory compliance review. Unless the client has spent a significant amount of time, effort, and expense obtaining a Part 135 charter certificate, they are probably operating under FAR Part 91. Generally, when operating under FAR Part 91 (also called noncommercial operations), the aircraft should not be operated “for compensation or hire.” The FAA’s definition of “compensation” is very broad. Compensation includes cash, nonmonetary considerations, and capital contributions to the operator by those receiving the benefit of the use of the aircraft.

Besides regulatory compliance, there are risk and tax issues to consider when determining whether the aircraft will be operated under FAR Part 91 or FAR Part 135. FAR Part 91 may impart more operational risk, but will allow a shorter depreciation period and not incur federal excise tax on the lease payments. Other tax issues to be addressed include passive activity tax issues when leasing the aircraft, state sales/use tax that may be imposed by multiple states, state property taxes, and the loss of tax deductions for entertainment use.

Additional Considerations

We have been reviewing regulatory considerations of a company aircraft.  If an employee of your client wants to fly the employee’s aircraft on business trips for the company, there are additional regulatory and risk-management considerations. Violation of the FAA reimbursement regulations carries risk exposure for the company as well as the employee. Your team should confirm under what section of the FARs the flights are to be operated. In addition, your team should review the insurance policies carried by the employee on the aircraft to confirm that the company’s interests are sufficiently protected, and should review the company’s employee health insurance, workers compensation, disability insurance, and travel accident insurance to verify that the policies cover claims from employees that might arise from these flights. The employee will be traveling on company business, and a gap in insurance coverages could become significant if an accident were to occur. The adoption of a company policy regarding an employee’s business use of the employee’s aircraft may be advisable.

As elections approach, be aware of applicable regulations if your client will provide flights to candidates for elected office. Failure to follow the regulations could land your client on the front page of a newspaper or a website in an unflattering article. Federal agencies that govern the use of a private aircraft by a federal candidate and his or her staff include the FEC, the FAA, and the IRS.

Now that you are aware of some of the regulatory requirements and potential pitfalls, your client may ask why they should care if they violate the FARs. The answer is that the FAA may impose substantial civil penalties on a per-flight basis that may be multiplied by several violations on a single flight. Depending on the violation, the FAA may also refer a case to the U.S. Attorney General. In addition, noncompliant operations may invalidate insurance, and the insurer could deny coverage on a multimillion-dollar claim. Finally, operations that violate the FARs may also subject the client to additional taxes, penalties, and interest if they are audited by the IRS.

Your client may also ask how the FAA discovers regulatory violations. Two common methods include an anonymous tip to the FAA or an aviation accident. Anonymous tips are not uncommon.  Aviation accidents are vigorously investigated by the National Transportation Safety Board (NTSB), and the truth will come out. The insurance company will also investigate accidents and may deny coverage because the aircraft’s operation at the time of the accident violated the insurance policy’s coverages.

Summary

Corporate aviation is a highly regulated industry. Assembling a knowledgeable team and performing periodic regulatory reviews are ideal steps toward helping your client achieve compliance. Facts surrounding the ownership and operation of the aircraft can change without consideration of the regulatory violations or without consultation with knowledgeable aviation advisors. There are viable options for complying with statutory and regulatory requirements when owning and operating a company aircraft and significant economic risks with regulatory noncompliance.

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