Beware the tax man…in another state

By DAVID HUGHES & CAROLYN SPRINCHORN

When Illinois Gov. Pat Quinn pronounced his fiscal house “on fire” in December 2010, many businesses and individuals in the state understandably feared that the lawmaker’s solution to the emergency would be reflected in their tax bills. Nonresidents, on the other hand, assumed they had nothing to worry about because they were beyond the state’s taxing power. However, a recent decision from the Illinois Supreme Court puts nonresidents on notice that the state may be turning to them to solve the current fiscal crisis.

The decision in Irwin Industrial Tool Co., along with other state-wide developments, highlights the importance of education and effective planning when it comes to aircraft ownership and state taxes. In particular, aircraft owners must be vigilant and creative to avoid falling into a number of state-tax traps that are being laid by state administrative tax departments in response to continuing budgetary woes.

The primary issue in Irwin was whether Illinois had the authority to impose a use tax on an out-of-state company that owned an aircraft that was occasionally flown into Illinois. The decision ultimately affirmed the Department of Revenue’s position that nonresidents must pay a tax when they land their airplanes in Illinois whether or not the airplane is based in another state.

In the Irwin case, the department claimed authority under the Illinois Use Tax Act to tax nonresident Irwin Industrial Tool Co. on the full purchase price of the airplane, which the Nebraska-based company bought in Kansas, took possession of in Arkansas, and hangared in Nebraska.

The Illinois Supreme Court agreed, noting the following facts: That Irwin maintained a corporate office in Illinois; that four out of Irwin’s seven corporate officers had their offices in Illinois; that the airplane made 272 takeoffs or landings at Illinois airports; that 36.9% of the total flight segments for the airplane were logged on flights to or from Illinois; that the airplane was present overnight in Illinois on 25 occasions; and that the airplane’s physical presence in Illinois was inherent in the company’s basic corporate purpose and function.

Following this decision, nonresident aircraft owners should be on alert that the use of their planes in states with which they have an otherwise minimal connection may result in a use tax liability. While credits are available for any tax previously paid to another state on the aircraft, the mere fact that the aircraft is based or hangared in another state is not enough to protect a nonresident owner.

A second trap for the unwary aircraft owner stems from taxes that may be assessed upon a transfer of a plane from one entity to another during a corporate restructuring. While many states provide tax exemptions for transfers that occur as a result of tax-free reorganizations, state statutes must be examined closely to determine the tax consequences of a restructuring. For example, the Illinois Department of Revenue has stated that the transfer of an airplane by a corporation to one of its affiliates for liability protection purposes constitutes a “transfer” under the Illinois Aircraft Use Tax and is therefore subject to tax. This transaction is a relatively common and otherwise seemingly harmless transaction that many companies and individuals undertake. Special purpose entities are often established to own aircraft in an effort, among other things, to protect the original owner from liability. What many aircraft owners do not realize is that the simple act of transferring title from one owner to another could result in an unintended sales/use tax consequence.

Since Irwin lowered the threshold for what it means to “use” property, states may be expected to aggressively pursue use tax collection against owners of aircraft, not to mention other mobile property, when they use their property in-state. This means it is more critical than ever for aircraft owners to understand and effectively plan for your tax future.

Exploring options such as participation in Voluntary Disclosure or Tax Amnesty programs is recommended. Depending on the exact circumstances, aircraft owners may be able to avoid an Irwin-type tax liability by closely monitoring time spent in different states with an eye toward taking advantage of “fly-away” exemptions. Generally speaking, such exemptions provide a safe-harbor to nonresident aircraft owners who remove their planes from the state within a specified period of time after a purchase and who do not return to the state during another specified period of time. For example, California requires the aircraft to be “promptly removed from the state and is not returned to California within 12 months after its removal from the state” to qualify for the “fly-away” exemption. Additional requirements vary state-by-state, necessitating a close look at applicable statutes prior to determining the best approach for tax purposes.

Aircraft owners are also strongly encouraged to keep close track of the taxes they do pay to various states in connection with the purchase, transfer or use of an aircraft, as most — if not all — states provide a system of crediting taxes owed for taxes previously paid. The exact rules involved can be quite complex, making accurate record keeping essential.

The tax consequences of aircraft ownership, once properly understood and planned for, may confidently be set aside, leaving freedom to pursue the business and personal goals that prompted the purchase in the first place.

David Hughes is an attorney with Horwood Marcus & Berk in Chicago, which represented Irwin Industrial Tool in its Illinois litigation. He concentrates his practice on income and sales/use tax matters. Contact him at 312-606-3212 or via e-mail at dhughes@hmblaw.com. Carolyn Sprinchorn is a contract attorney with the firm.