As I flip through the pages of various aircraft publications and websites, I often run across ads or articles telling potential owners of the sales and use tax benefits to owning an aircraft in an out of state company. This is also one of the first questions I am asked when I receive a call from a potential owner; how can I set up an out of state company to purchase an aircraft? My first question back is what kind of business will it be? The person at the other end says there is no “business,” it will be a company to own the aircraft.
It doesn’t seem to matter whether your passion is vehicles, boats or airplanes, somebody from one of the five states in the U.S. that have no sales tax will set up his tent along side the road and begin selling you on the idea of avoiding sales and use tax. There is nothing in the law that prevents you from establishing a corporation in one of these states; it is perfectly legal. However, owning a corporation or LLC in a state that has no sales tax does not preclude your corporation from owing sales tax in another state.
If your accountant advises you to use a corporation in a state other than the one you live in for IRS purposes, he probably knows what he is talking about. If your attorney advises you to use a corporate structure to minimize personal risk, you can be reasonably certain that he knows his area of expertise. However, if anyone leads you to believe that owning your personal property in an out of state corporation or LLC will legally avoid your sales or use tax obligation in the state where you store and use the property, you are being led down a path of financial destruction.
There are many people who believe that by registering their aircraft in the name of an Oregon, Montana, Alaska, New Hampshire or Delaware Corporation or LLC, they have legally avoided sales and use tax. The truth is they believe it because they haven’t been caught yet. Their ignorance of the law will not be a valid defense when their case has to be argued in front of the state taxing authority. The fact that they have been told by 50 people in their aviation club how “Joe and Jane” didn’t pay sales tax doesn’t change the brutal truth for John. Every person who has used an out of state corporation or address to register their property is juggling a hand grenade with the pin pulled. In fact, the longer they juggle it, the more dangerous it becomes.
The following hypothetical story is intended to explain the dangers.
In January of 2000, John Doe of San Diego, California was planning to purchase a King Air 350 to fly around the United States, Canada and Mexico for pleasure. Life had been good for John so he could afford an $8,000,000.00 aircraft. After locating several potential aircraft to purchase, John began to research the ultimate cost of ownership; fuel consumption, maintenance, hangar fees, insurance etc. In discussions with one of the salesmen, John was hit with the reality of having to pay an 8% sales tax, which on an 8 million dollar aircraft would equate to $640,000.00.
John began to pay attention to the ads about buying the aircraft in Montana or other tax advantageous state. By March he was ready to commit to the aircraft purchase. John contacted an attorney from an ad that he had saved saying that a Delaware Corporation/LLC would eliminate the sales and use tax on the purchase. The attorney took care of legally establishing the Delaware Corporation and John purchased the aircraft in the name of XYZ, Inc. with the Delaware address listed on the FAA Bill of Sale and FAA Registration. John flew via commercial airlines to Oregon to accept delivery of his new King Air 350 and immediately flew it into California where it would be based in San Diego, CA.
For the next several years John seemed to literally fly under the California sales and use tax radar. In May of 2006, John decided he wanted to re-register the aircraft to his California address. Soon after the re-registration, a letter from the Consumer Use Tax Section (CUTS) of the California State Board of Equalization (Board) arrived in his mailbox, requesting the details of the purchase. The hand grenade had all but detonated.
John’s attorney filed the tax return for the aircraft claiming that the corporation was an out of state resident and the purchase took place in Oregon. In addition, the attorney indicated the statute of limitations had expired and therefore the transaction fell outside the reach of the Board.
The Board’s response was that it didn’t matter who owned the aircraft. They forwarded a letter which outlined excerpts from the California sales and use tax code, Regulation 1620, which states in pertinent part:
“Property purchased outside of California which is brought into California is regarded as having been purchased for use in this state if the first functional use of the property is in California. When the property is first functionally used outside of California, the property will nevertheless be presumed to have been purchased for use in this state if it is brought into California within 90 days after its purchase, unless the property is used or stored outside the state of California one-half or more of the time during the six-month period immediately following its entry into this state.”
The countdown to explosion had begun.
The accountant filed a statement and documentation which claimed the aircraft was purchased for out of state use. He included flight logs and fuel receipts for numerous flights between California, Texas, Florida, Washington, New York, Arizona, Oklahoma, Kansas, Canada and Mexico during the first six months of ownership.
The Board responded that even though the property was purchased outside the state, it entered California within 90 days and did not meet the 50% out-of-state storage and/or use requirement. Therefore, it was presumed the aircraft was purchased for use inside California. The Board issued a Notice of Determination (Bill) on August 20, 2006, totaling $1,203,200.00; ($640,000.00 in tax, a $64,000.00 failure to file penalty of 10% and $499,200.00 in interest at 12% per year, by 6.5 years). Included in the Notice was a warning that the interest accrued an additional $6,400.00 each month that the tax remained unpaid.
John Doe brought his attorney into the case along with his accountant to file a Petition for Re-determination to have their case reheard. Six months later an appeals conference was held and the taxpayer’s representatives used the previously submitted documents to support that the aircraft was purchased for out of state use. They claimed that the majority of the use of the aircraft since the date of purchase had been in traveling to locations outside of California. The Board staff responded that since the aircraft entered the state the same day it was purchased, the only time that would be evaluated was the six month period following the date of first entry into California.
The representatives responded that in Regulation 1620 it states, “unless the property is used or stored outside the state of California one-half or more of the time during the six-month period immediately following its entry into this state.” They asserted that John’s flights to Texas, Florida, Washington, New York, Arizona, Oklahoma, Kansas, Canada and Mexico during the six-month test period constituted more than 70% of the total flight time traveled. It was their assertion that because the regulation states that the property must be used “or” stored more than one-half the time, the aircraft was exempt.
The Board’s staff responded to the contentions that for the last several years the Board had been interpreting that the property must be used “and” stored for more than one-half the time. Therefore, the percentage of flight hours flown inside of California versus outside of California meant nothing in this case.
The representatives responded that when you take into account the time the aircraft was in out of state locations, the actual total exceeded the 50 percent requirement in the Regulation. The Board responded that fuel receipts only prove where the aircraft was located at the moment of the purchase, and less than 15 receipts were submitted. Often there were periods of time in excess of 10 days where no receipt was provided. The reps responded that they provided two monthly hangar rental receipts from an airport in Canada for the months of February and May 2000. The staff countered that even though the taxpayer had provided the receipts for those months, it did not prove the aircraft never re-entered California during that time.
The attorney and accountant moved to the flight logs as serving as documentary evidence of the whereabouts of the aircraft during the six-month period, however the Board auditor had searched various online flight tracking sources to discover that although a majority of flights were documented in the logs, there was a material discrepancy documenting more than 20 un-logged flights.
The representatives then asserted that the period of time that has expired from the date of purchase was in excess of six years and it was impossible to recreate a document trail to establish that the taxpayers had supported their claim for an exemption. The staff simply reminded the reps that it is the taxpayer’s burden of proof, not the staff’s burden to prove the exemption was not supported.
In addition, the Board auditor determined that the Delaware Corporation was simply set up to register the aircraft to avoid the tax and recommended a 50% penalty be added for knowingly registering the aircraft outside of California with the intent to evade the tax. The Board came to this conclusion by determining there was no business conducted by the corporation, the location of the business was a Post Office Box and a forwarding agent was used for incoming mail.
On June 7, 2007, John received a Decision and Recommendation from the Board. The appeal was denied due to the aircraft not being adequately stored and use outside the state of California in excess of 50% of the time during the first six-month period immediately following the first entry into this state. In July 2007 John received a Notice of Re-determination totaling $1,607,680.00 in tax ($640,000.00), interest ($583,680.00), 10% failure to file penalty ($64,000.00) and a 50% intent to evade penalty ($320,000.00).
On April 4, 2008 John wrote a check to the Board for over $1,607,680.00, after exhausting a settlement offer with the Board and an oral hearing before the elected members of the Board of Equalization, who found the staff’s positions within the laws and regulations. After adding to the bill over $35,000.00 in legal and accounting fees that were incurred for establishing the out of state corporation, filing its returns, and for the representation before the California State Board of Equalization, the time had finally run down to zero and the grenade detonated, inhaling nearly all of John’s liquid funds. John is currently trying to sell his King Air 350 to replace the equity in his home, which he borrowed against to pay off his debt.
The sad truth is that John could have legally avoided the tax in California. He didn’t need the Delaware Corporation and he could have registered the aircraft to his California address. Instead of hiding in a bomb shelter and waiting for an explosion, all he had to do was wrap him self in the armor of a specialized program that is prepared by sales and use tax experts who understand the way the Board works from the inside.
By: Joseph F.R. Micallef
