Although I didn’t personally attend AirVenture this year (lots going on in my “retirement”), my friend and successor at AOPA Flying Clubs, Cade Halle, was extremely busy with seminars, the Flying Clubs social event, and answering a multitude of questions about starting and running flying clubs.
Two topics quickly permeated to the top of this year’s list of “FAQs”. The first, navigating the legal and tax structures for flying clubs (old or new…no difference), which is the topic of this Question of the Month. Close second, that we will tackle next month, is how a club can be prepared, ahead of time, if an aircraft/member is involved in an accident. This gets interesting very quickly as it must include: who to contact and in what order, legal and financial implications, insurance ramifications, lessons learnt, review of operating procedures and rules, member training and more. Stay tuned for more on this important topic next month.
Even though we have written and spoken previously about the broad topic of club structure, at first blush it can appear to be a confusing and difficult topic, and one that often sends club founders—and even seasoned board members—scurrying to legal firms that promise to do the work for them, for some suitably large fee. This is certainly an option as it frees-up time to work on other club matters, like acquiring an airplane and writing bylaws, but as always, due diligence is key. As with other professionals, lawyers tend to specialize, so your local estate planning lawyer may not have the skills or deep knowledge to correctly set up a non-profit flying club. I’ve also come across experienced business lawyers who are perhaps set in their ways and end up establishing completely inappropriate legal and tax structures for a flying club. So, whether you do it yourself, which you will be able to do after reading this article and its references, or if you decide to pay someone to do it, it would behoove you to understand the details of how it should be done. Then, by that time, you will be at least 85-percent through the process, so might as well finish it off yourself! On the other hand, if you still decide to use a professional to do the actual filling, at least you know enough to steer, guide and, yes, push-back, as necessary.
Start a Club Checklist:
Let’s first take a step backwards and look at the 50,000’ level of starting a flying club—then we’ll expand for this “sujet du mois”. Our “Checklist For Starting A Flying Club” (found here) lists seven main stages in club formation:
Each of these stages depends to a large degree on previous steps. Topical here is that “Play by the Rules” includes choosing between equity or non-equity ownership, selecting a legal structure and then considering a suitable/applicable tax structure. Each depends on the other and definitely comes as a result of really understanding the “Get Organized” stage, which sets the foundation for the club in terms of its mission and culture—from this will come a clearly (well, less muddy) picture of candidate aircraft. All of this, in fact all of the steps in the checklist, are greatly amplified in the encyclopedic tome, “Guide to Starting a Flying Club”, found here.
Now, whilst all of the above steps and the discussions resulting from them are essential in establishing the “essence” of a new club and will most definitely lead the founding members down a guided path for success, it turns out that the legal structure of a flying club, operating as defined by the FAA, is not actually a link in the chain of uniqueness, and is independent of any/all of this and so doesn’t actually depend on the number of members, club objectives, type of aircraft and so on.
Gosh—that is quite a statement, so I’ll develop this conclusion in a logical way.
Flying Club Legal Structure:
Firstly, flying clubs operating in the USA are governed, as are all aviation activities (except military), by the FAA. I’m not going all “big government” here, but I believe this is actually a good thing. Aircraft, pilots, flight schools, flying club operations and so on do not care about state borders (although state’s Departments of Aeronautics can, and do, “localize” rules and requirements such as sales taxes, additional registration and so on), so it makes perfect sense that the National Airspace and operations therein, are governed by a federal agency.
An argument I hear from independently minded hopefuls is that, as flying clubs are not regulated under the FARs (strictly, CFR Title 14, Aeronautics and Space), they can essentially do want they want. Whilst it is true that flying club formation, governance and operations are not explicitly called out in the FARs, we all know that the FAA has other ways to impose expectations and “guidance”. For example, the AIM, Advisory Circulars, Letters of Determination and FAA Orders. In particular, the blurb for FAA Order 5190.6B (now at change 3) states: “Order 5190.6B sets forth policies and procedures for the FAA Airport Compliance Program. It provides basic guidance for FAA personnel in interpreting and administering the various continuing commitments airport owners make to the United States as a condition for the grant of federal funds or the conveyance of federal property for airport purposes. The Order discusses the obligations set forth in the standard airport sponsor assurances, addresses the application of the assurances in the operation of public-use airports, and facilitates interpretation of the assurances by FAA personnel”.
This might seem a strange digression, but stay with me. Chapter 10 (section 10.6) of FAA Order 5190.5B explicitly focuses on flying clubs. If you intend to form and operate a flying club at an airport that has accepted federal funds for improvements, then the airport “sponsor” (state, county, city, etc.) signed an agreement with the federal government referred to as grant assurances. That airport becomes obligated to ensure that it operates and provides access and opportunities as defined in the Order. This applies to flight schools, FBOs, other commercial operators…and quite differently, flying clubs. Now, the FAA itself will not likely police this directly, but they do expect airport operators to honor the conditions of grants or suffer the consequences. As a side note, privately owned but public use airports are also held to these standards if they have accepted federal funds—and many have.
All well and good—but how do you know if your airport is federally obligated and so must comply with FAA Order 5190.6B, and hence that you must comply with section 10.6?
As another side note, this is why the FAA gets so steamed up when airport operators (municipalities, counties, etc.), unilaterally decide that they are going to close an airport and flog it off to some developer, or the airport sponsor decides to stop selling a particular type of fuel, if you know what I mean. “Oh, no you don’t”, say the FAA, and they will summon the full force of the federal government to ensure that obligations are honored for the duration of the agreement.
Okay so far, but what does FAA Order 5190.6B actually say about flying clubs? Plenty, so I suggest you read and re-read section 10.6 (link at the end of this article) to really understand how a flying club is expected to behave, including equal ownership, absolutely no commercial operations, and the rules for club members and CFIs when using club airplanes for compensated instruction. In terms of this article, the key words are contained very early in section 10.6, Flying Clubs:
Pretty clear…right? A flying club is a non-profit entity for personal and enjoyment only, and is not an FBO or some other commercial operator.
Given that clubs have assets and members, the next logical step is to structure in a way that provides liability protection against anyone who decides to sue the club, for whatever reason. This is achieved by establishing a business structure in the state of operation.
Putting the two together, the only structure that ticks all boxes is a non-profit corporation (NPC), established in your home state. This is remarkably easy to do as all states have one-stop-shop on-line portals to do just that. As examples, in Maryland there is Maryland Business Express (https://businessexpress.maryland.gov/), and in Oregon there is Business Xpress (https://www.oregon.gov/business/Pages/index.aspx). For other states do an internet search for “Start a New Business in <State>” and select the site that has a .gov URL. Be warned, the first few results will be from companies that want to charge you lots of money to do what you can do yourself by following the instructions on the government websites. Some people may lament “what if I get it wrong…?” Well, even though you apply on line, a real person will review your application and will get in touch if they need more or missing information. If you spend the time to read the instructions on these websites you will not get it wrong…and it takes about the same amount of time for you to apply than it does to explain to a lawyer what you want.
When you use these portals, the first thing you will need to do (well, apart from ensuring that no one else is using the business name that you want for your club), is to select the type of corporation, and we have already established that it should be a (domestic, non-stock) Non-Profit Corporation (NPC). Not a C-Corp, not an S-Corp, and not an LLC. Some club members and many lawyers will try to persuade you that an LLC is a simpler structure for a flying club, but they are just plain wrong! An LLC, by definition, is expected make a profit for its owners, and as we have seen, the FAA state that flying clubs must be non-profit entries. There is just no such thing as a non-profit LLC—more on this in the next section, dealing with taxes. One argument proffered for an LLC is that there is no requirement to have bylaws and a governance structure—board of directors, officers, etc. Whilst that is a true statement, wouldn’t you want to be a member of a club that has a well-documented structure, that follows tried-and-tested governance practices and is professional in its operations? Yes—of course you do!
So, in a nutshell—set up an NPC and nothing else.
One other thing to discuss on the topic of business structure. Once you have established the club’s NPC, keep reading the info on the portal—but this time look for information regarding your annual reporting commitments. Every business entity in every state is required to file an annual report—the details, methods and fees are on the specific on-line portal. Please, please, please be really diligent about this and ensure that your Treasurer and/or CPA are fully aware of this (non-tax) filing requirement. I’ll include a link to another article on the topic of “Being in Good Standing” in the references.
If you are reading this and are getting worried since your club is set up as an LLC, you have choices.
Flying Club Tax Structure:
A flying club’s business structure and its tax structure are two different things—intimately related, but different. As above, let’s tackle this in a logical fashion (if that is possible with taxes).
Firstly, every flying club, whether NPC or LLC or whatever, is required to file tax documents—both federal and state. A problem can arise due to the somewhat transient nature of a club’s Board of Directors (BOD), especially the position of Treasurer. It is imperative that an incoming Treasurer is well briefed by the outgoing one, although I do know of clubs that have had the same Treasurer for years, and suddenly discover that they haven’t been filing tax returns…oh, dear.
What a club needs to file (IRS and state forms) depends on the tax structure, but I’m getting slightly ahead.
Once you have established the business structure, you will apply to the IRS for a tax number. For a corporation, this is called the Employer Identification Number (EIN) and is essentially the equivalent of an individual’s Social Insurance Number that we all enter on our 1040 tax returns each year. Again this is remarkable easy to do and you do so here. Yes – I know the club will likely not be employing people (if you get tempted to do so, read this article first and even then, be careful what you wish for), but EIN is what it is called.
There are two reasons for getting an EIN. Firstly, you will need it in order to set-up bank accounts in the name of the club (and you definitely want to set up bank accounts in the club’s name). Secondly, you need it to file the club’s tax returns, so now we need to talk about taxes and tax exemption. When you receive the letter from the IRS containing your EIN, it will include a section informing you of the tax form you must use when filing annual federal taxes. Unless you make changes to the tax structure, you must file the required form every tax year. Please note very carefully that just organizing as a non-profit corporation in your state does not automatically make that entity tax exempt—neither with the feds nor the state tax board.
Let me be clear about tax exemption and LLCs—it won’t happen, although some “experts” may state that they have done it. Even if they have, it is just a matter of time. So, for the correct structure of an NPC flying club, what are the tax opportunities? Well, a flying club, which as far as the IRS is concerned is a type of social/hobby club, can apply for federal tax exemption under 501(c)(7) tax rules. Basically, given that a hobby club is funded by dues, and those dues come from members’ income that has already been subject to tax, the IRS give us the opportunity to not pay tax twice. Gosh! I say “opportunity” as we have to do a bit of work to get this. Once again, it is not difficult but needs careful attention, but yet again, people are waiting in the wings to extract lots of money from you for something you can do yourself, with a modicum of diligence. Just like there is only one correct business structure for a flying club, there is only one correct pathway to tax exemption. Some people will try it on (and probably lie to the IRS in the process) by claiming that their flying club provides training and so they should receive tax exemption as a 510(c)(3) educational charity. This has certain advantages to donors, but also severe disadvantages in terms of asset distribution if the club was to fail. The real problem is that flying clubs cannot provide training as to do so will put it at odds with the FAA and Order 5190.6B regarding commercial operations. Therefore, a flying club trying it on as a 510(c)(3) entity will not be able to simultaneously satisfy the requirements of the FAA and IRS. Which of these agencies will you pick to be at odds with?
Anyway, the correct method for a flying club to apply for tax exemption is under IRS 510(c)(7). You’ll use Form 1024 for the application process. As with all tax forms, be sure to download and really understand the form’s instructions (here). I talk more about this form in The Guide to Starting a Flying Club and there is an example Form 1024 on the Downloadable Resources section of the AOPA Flying Clubs website. Take your time with this form and especially page two, the narrative.
You’d probably think that every flying club should of course apply for IRS 510(c)(7) tax exemption, but there is one situation where any tax advantage may be diminishingly small. An NPC is not obligated to file for tax exemption and indeed a new club may decide to wait to determine its tax situation before spending the $800 filing fee (one time) that must accompany Form 1024. This situation applies to a non-equity club, where, by definition, the club doesn’t own an aircraft, but rather leases it. A correct and carefully crafted lease agreement should make it crystal clear that the owner (the lessor) should be responsible for all maintenance that: a) applies to airworthiness and b) maintains or adds value to the airplane. Case in point are the large-ticket items of engine, propeller and other time-limited components. Now, for all flying clubs, the per-hour usage fee that members pay (never call it “rental”), will include a component for this type of maintenance—the engine fund, for example. A non-equity club passes this through to the lessor, whereas an equity club maintains the fund themselves. In other words, an equity club brings in more money that it (immediately) needs every year, in order to build reserve funds, and so income-less-expenses will be a relatively high number and taxable, and that’s why an equity club should apply for tax exemption. On the other hand, a non-equity club can operate in more of a break-even manner. Yes – such a club does need some reserve funds but not to the extent of an equity club. My advice to all new clubs is to wait at least a year before applying for tax exemption in order to determine the actual tax obligation, and then compare it against the $800 filing fee.
I need to make another point here that tends confuses people. Non-profit doesn’t mean that the entity cannot have a positive bank balance. Any organization, especially flying clubs, require proper funding to remain operational. The point is that in an NPC, any “profit” is not distributed to shareholders or anyone else—it is retained by the entity itself.
Now let’s talk about the actual tax forms to file every year.
We’re almost there! Here is summary in checklist format of what you need to do on the topics of legal and tax structures. My advice is to do your homework and decide if you are comfortable doing it yourself. Remember, AOPA members who have the Pilot Protection Service add-on may call AOPA lawyers for advice and document reviews on behalf of their flying club.
Notes:
Bottom line: Setting up a club’s legal and tax status is highly procedural and very well documented. Just like with flying, do your homework, brief the process and do a risk assessment!
As always, fly lots and fly safely!
References Pertaining to Club Legal and Tax Structure:
The Guide to Starting a Flying Club. Specifically, Chapters 4 and 6:
Checklist for Starting a Flying Club:
Previous Relevant Question of the Month articles:
Question of the Month: What Does “Good Housekeeping” Mean to Flying Clubs?
Question of the Month: What does “being in good standing” mean for flying clubs?
Question of the Month: What Are the Pros and Cons of Equity and Non-Equity Flying Clubs?
Question of the Month: Can a Flying Club Employ People?
Flying Clubs Radio Editions:
Edition 46 Top Ten Questions We Get Asked
Edition 41 Flying Clubs and Your Airport Manager
Edition 40a Corporate Structure for Your Flying Club
Edition 40b Club Corporate Structure and Tax Exemption
Useful websites and documents:
FAA Order 5190.6B (Change 3), full document—see section 10.6 for Flying Clubs: https://www.faa.gov/documentLibrary/media/Order/Order_5190.6B_Compliance_Chg3.pdf
FAA Grant Assurances: https://www.faa.gov/airports/aip/grant_assurances
Apply for an EIN: https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online
Apply for IRS Tax Exemption: https://www.irs.gov/charities-non-profits/applying-for-tax-exempt-status
IRS Tax Exempt Corporations Search Tool: https://www.irs.gov/charities-non-profits/tax-exempt-organization-search
