Understanding the “Flight Department Company” Problem
Owning an aircraft can save company executives time and add prestige to brands. But companies should carefully review the tax consequences, which can be substantial depending on how the aircraft agreement is organized. One very basic question should be resolved before the purchaser commits to the acquisition—what entity will own and operate the aircraft?
Lawyers unfamiliar with the nuances of the Federal Aviation Regulations (FARs) may advise their clients to create a separate corporate entity for the purpose of owning and operating [1] business or personal aircraft. The reason for doing so is perhaps obvious—operation of an aircraft may be perceived as risky, and segregating that activity into a separate limited liability company (LLC) or other entity may be suggested as a way to mitigate that risk. The thought process is that such an action would protect a parent company or affiliate, or personal assets, by shifting potential liability to the separate “sole purpose” or “single purpose” entity.
But there is one problem—operation of an aircraft by one person or entity for the benefit of another person or entity in this arrangement may be illegal under the FARs unless the operator goes through the expensive process of obtaining additional certification. [2] To understand why, we turn to the FARs concerning commercial operation.
Federal Aviation Regulations (FARs) on Commercial Operation
14 CFR Part 91 provides the general flight rules applicable to flights that do not involve the carriage of persons or property for compensation or hire. The prototypical example would be a private pilot operating their own airplane for their own personal use. Part 91 also applies to businesses providing transportation “within the scope of, and incidental to, the business of the company (other than transportation by air).” [3] Put differently, a company may operate its aircraft pursuant to Part 91 regulations when the use of the aircraft is within the scope of the company’s own business, so long as the transportation being provided is not the business that the company is in. If there is any doubt, the Federal Aviation Administration (FAA) will consider “whether the carriage by air is merely incidental to the person’s other business or is, in itself a major enterprise for profit.” [4] For example, a commercial airline may transport its employee under Part 91 to a company-related business meeting (within the scope of and incidental to its business), but because the company is in the business of providing persons or property for compensation or hire, it cannot fly a paying customer under Part 91. [5]
On the other hand, a commercial operator is “a person who, for compensation or hire, engages in the carriage by aircraft in air commerce of persons or property.” [6] A typical example would be a charter company that provides an airplane and pilot for transportation to a customer’s desired location. But the freedom to engage in this type of flight-for-hire business comes at a higher financial cost. The commercial operation rules are more stringent, and it is more expensive to comply with them. Thus, a company seeking to purchase and operate a business aircraft to transport its own employees and guests, rather than enter the charter or air carrier industry, would naturally prefer to operate under Part 91.
However, when a company (or individual) sets up a separate entity just to operate an airplane, the FAA has dubbed these entities “flight department companies,” and taken the position that these “flight department companies” are illegally providing transportation for compensation or hire. [7] While in other contexts (i.e., federal tax rules), an LLC might be considered as a disregarded entity, under the FARs, the entities are distinct from each other. So even if the flight department company is a subsidiary—and likely transports people and goods within the scope of the parent company’s business—because the flight department company is a separate entity primarily providing air transportation, its activities constitute commercial operation. This is true even if the parent company does not pay specifically for the flights at issue because the FAA has taken the position that compensation may come in the form of capital contributions or other funding necessary to support the “flight department company.”
Risks of Operating a Flight Department Company
There are costly risks associated with falling into the flight department company trap. For example, a flight department company may be subject to a 7.5% federal transportation excise tax on the value of each flight. Further, flight department companies engaged in commercial operation must obtain an authorization from the FAA pursuant to Part 119 appropriate to the types of operations and aircraft size. The FAA may also take legal enforcement action for noncompliance, which may result in pilot license suspensions or revocations and monetary civil penalties ranging from $1,100 up to $25,000 for every flight. [8] In the event of an accident, insurance companies may invoke illegal operation clauses resulting in insurance coverage denial. Moreover, enforcement actions are made public, exposing violators to public scrutiny and potentially damaging the company’s reputation.
Solutions
There are a number of ways to structure business aircraft ownership to avoid illegal commercial operation. The following are a few examples:
- The parent company can refrain from creating a separate LLC, and instead own and operate the aircraft through its existing operating entity. This option allows the parent company to continue to operate the aircraft under Part 91. Although this structure exposes the parent company to potential liability arising from use of the aircraft, under this option, the costs associated with maintaining a separate entity may instead be directed to defraying the cost of acquiring additional insurance coverage.
- Adding more businesses to the flight department company would allow the entity to remain subject to Part 91 because the business purpose would no longer be solely air transportation. However, the other business operations must be substantial enough such that they comprise the primary business of the company.
- The flight department company could own the aircraft and “dry lease” it back to the operating entity or to a third party, which would operate the aircraft. The FARs proscribe flight department companies from operating aircraft, not owning aircraft.
The above is not an exhaustive list of possible ownership and operational structures. Prospective owners should carefully consider their unique circumstances and requirements to pick a solution that works best for them.
This article features reporting from Law Clerk Elizabeth Hein.
