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Beware: Yacht Charter
or IRS Audit Trap
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Don't let your charter boat business become an IRS tax trap.
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Want more time on the water, at less cost and risk?
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Think the answer is owning a charter yacht "business"?
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Could you be inviting the IRS to audit your boat "business"?
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Are you on the IRS' radar? Already a target for an audit?
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How would you know? What can you do? Is it too late?
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Are you really taking tax advice from those paid to sell you a boat or to "manage" your boat in a charter "business"?
Free yourself before the IRS closes the trap on you.
YES is Your Escape Strategy.
Our mission is to ensure adequate resources - both time and financial- to fully satiate yours and your family's demand and desire for all the best the yachting lifestyle has to offer.
But suffice it to say, we are concerned by what appears to be the increasingly common fraudulent practice of attempting to defray and disguise the expense of the yachting lifestyle with the tax ruse of a charter yacht business.
The IRS may be slow, but they are not stupid. The tricks, scams, and schemes to game the system may work for a while, and sometime a long while and be peddled by impressive professionals, but the IRS will eventually catch on. Son of Boss for example. Sometimes the tax code changes - or judicial interpretation changes - making what but used to be legal, now not so much. Unfortunately while many CPAs are in the dark, promoters often mistakenly continue to tout a program's previous historic success (staying out of jail or meeting the tax code requirements at the time) as some type of current validation. That's not necessarily so.
All the more, now with the most sweeping changes to the tax code in a generation - the Tax Cuts and Jobs Act of 2017 (TCJA) and now the Inflation Reduction Act.
It's generous depreciation treatment will likely become an open invitation for unscrupulous yacht brokers, their shills and cronies to prey upon the unsophisticated. Like many Multi-Level-Marketing pyramid schemes, but designed to sell boats, these packaged boat charter business schemes are not really designed to ever make a net after tax profit - just an attempt to try to work the tax code for some potentially high risk questionable tax breaks.
Ironically, there are provisions in the TCJA that makes such a charter business scam unnecessary. Provisions that enable a tax payer to reduce their taxes sufficiently so that they don't need to fake a business or lie about a profit motive just to be able to afford a boat. TCJA provisions when properly structured, can provide enough funds just from tax savings to more than pay for a boat without ever having to charter it or claim bogus business deductions.
But alternatively, lest we give the mistaken impression, let us be clear - properly structured and managed - YES yacht ownership can be a profitable investment.
And as such, it is "possible", if executed properly to provide significant benefits. In fact, it can be the ultimate liquid investment.
But therein with the opportunity - lies part of the problem.
Too few yacht charter operations are properly structured and proficiently managed - to either avoid, or stay out of any tax trap to start, or able to free the owner before it's too late.
NOT ONE CPA GOT IT RIGHT - So why believe someone trying to sell you a boat?
The Chairman of the House Ways and Means Committee U. S. Congressman Kevin Brady reminds us that most CPAs are not even correct on simple matters. He cited the policy paper number 130 by David Keating the senior counselor of the National Taxpayers Union, and particularly the section "Experts Agree They Can’t Agree on Tax Bills", referring to the Money magazine tax projects, For many years, Money magazine’s annual test of CPA's for a hypothetical household proved that paid tax professionals often make huge mistakes.
In 1998, the last year Money administered the test, all 46 tested tax professionals got a different answer, and none got it right. The professional who directed the test admitted “that his computation is not the only possible correct answer” since the tax law is so murky. The tax computed by these tax professionals ranged from $34,240 to $68,912.
Not one of the CPAs got it right. For just a minimal simple family tax return, the subject tax liability varied by a range of more than 100%. And that was just between a small sampling of just 46 CPAs. (It makes one wonder about the variance in complex tax returns.)
He also documents in the policy paper the situation has not improved in recent years but probably worsened. If most CPAs have such difficulty with just simple tax returns, how many general practice CPAs do you think fully understand the nuances of the yacht charter business? What about your current team? Will they get your yacht charter business correct? How will you know? How confident are you of their industry expertise?
If tax professionals can't be trusted to get it right, how can you trust a yacht broker or charter management company that is trying to sell you a boat to put it in a charter "business" that they or their affiliate will manage?
They might be boating professionals - but they are certainly compensated ONLY if you buy a boat or place it with their charter management company. Are their interests the same as yours? Can a full time boating or charter professional- or anyone with a financial interest in the yacht transaction- be trusted to provide competent tax and business advice?
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How to prevent possible IRS tax issues from the start,
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How to prevent tax issues developing in the future as the operation develops, and
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How to identify and resolve any potential tax issues BEFORE they are IRS tax problems.
Often the yacht owner may not even know of the problems - until it is too late. Everyone else involved with the yacht makes a profit- starting from day one - except the yacht owner - who is usually left alone, holding the bag, and answering to the IRS.
MORE BOAT & LEISURE TIME FOR LESS - less cost, less risk, less stress, and less uncertainty.
We are not against charter yacht operations per se, but caution how many yacht / sale charter management programs are promoted, packaged, and managed with the primary objective being to sell boats and provide charter inventory for the charter yacht management company while the boat owner pays for it. This is often to the exclusion of alternatives more beneficial to the actual yacht owner.
It's not so much what the yacht brokers say while promoting their schemes, but often it is what they don't say. Many fail to make full disclosure of the risks and uncertainties. They often cite the rules and regulations and a tax court ruling or two without disclosing those cherry picked examples are the exceptions and not the rule. Their examples usually have some mitigating circumstances unique to that single tax payer that distinguishes them.
In their own words
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Usually for every case the promoters cite as an example as to how easy it is to comply, there are many more rulings the other way. Most taxpayers settle disputes with the IRS long before trial, but of those that go to tax court - the IRS wins about 80% of the time.
Then there are potential tax issues that NO yacht broker, promoter or charter yacht manager dares to bring up. One CPA working with these programs confided the lack of full disclosure was because, "I don't want to scare anyone off".
Compared to most yacht management companies that sell boats and then manage the charter, now there are just too many superior economic and tax alternatives that are much more rewarding with less risk and uncertainty. At least for the yacht owners - maybe not so much for the promoters. In fact, for achieving net worth neutral yacht ownership, the increased risk of charter exceeds any tax benefit. But old habits- even bad habits- can be hard to break.
For the savvy and financially sophisticated yacht owner, yacht charter is now perhaps the least desirable and efficient strategy to offset the expense of yacht ownership and to profit from the yachting lifestyle. Even without considering the potential adverse tax consequences.
Traditional yacht charter and the increased IRS risk is no longer necessary for prudent yacht owners
Yet every year, yacht brokers successfully talk many yacht owners into buying a yacht with the closing sales pitch,
“You can always put the yacht in charter to recover some of your costs and receive tax benefits. And by the way, our yacht management and charter broker services can handle everything for you”.
Recently, there has been a growing trend of various schemes promoting packaged boat sales and charter management deals with such enticing monikers as boat as a business and business yacht ownership promising to "OFFSET 80% - 100% OF THE COSTS OF A NEW YACHT WITH TAX ADVANTAGES AND INCOME".
Well maybe, maybe not.
Contrary to what the salesmen, brokers, promoters and shills purport; the application of the tax code is seldom that cut and dry. Most CPAs, attorney's and financial advisors can't keep up with changing rules, regulations and their evolving interpretation. Often what works for one tax payer will not work for others. Even what works today, may not in the future.
Tax courts and the Federal bench long ago established that the interpretation and application of the tax code - especially Section 183 the business or hobby determination - is often a question dependent on the specific facts and circumstances unique to the situation of the individual tax payer AND can vary from year to year even with the same taxpayer.
"Thus, even if we were to assume that petitioner had a profit objective before the subject years, we would still not be persuaded that he retained this objective during the subject years. In order to escape the grasp of section 183, it is not enough to have a profit intent before the years in dispute. The taxpayer must possess the required intent during the year in issue."
Or as the IRS explains it regarding boat owners and the yacht charter "business":
“The IRS' goal is to deter taxpayers from using a yacht-chartering business as a way to purchase a yacht for personal enjoyment and then deduct losses for the yacht-chartering activities.”
We suspect over the last few years with the sluggish economy and the tax stimulus to spur the purchase of capital assets, that many more yacht owners have been - and continue to be- talked into buying a yacht by the promise they would be able to take advantage of the accelerated depreciation schedules available for business owners.
The problem with buying a yacht and taking tax benefits derived by placing it in a “charter business” is that very few “charters” actually meet the IRS definition of a business. Regardless what any broker, salesman or their cronies may tell you.
Thus, if your activity fails to meet the IRS definition of a business, you can’t take business deductions.
Do your yacht activities qualify as a business under the IRS regulations?
If your yacht charter business has not made a profit in three (3) out of the last five (5) years- and not just a minimal profit, but a significant net after tax profit relative to other factors - the odds are against your charter activity qualifying as a business - according to the IRS.
A New Direction
in Marine Marketing
When achieving your
financial objectives
requires a change of course-
So, how much net profit does your charter business generate?
And if your boat charter business has not made a significant net after tax profit in 3 out of the last 5 years, then the burden shifts to you the taxpayer to prove that you operated a legitimate business with a true profit motive. And in every year in question, in every year at issue.
Do you know what it costs to go to tax court and try to prove your primary purpose for the boat charter business was to earn a significant net after tax profit? Do you know the potential consequences if you are unpersuasive? It could be much more than just monetary penalties and fees if any type of fraudulent act or omission was identified.
Charter boat ownership? A business or something else?
As a matter of fact, few yacht charter businesses ever earn any net profits – much less any significant profits three out of five years. Thus many fail to qualify as legitimate business enterprises.
The IRS thinks this is such a target rich environment that it is now specifically targeting for audits those yacht owners that claim business deductions of their yacht charter activities.
The IRS regularly conducts national, regional and local compliance initiative projects (CIPs) to study perceived areas of noncompliance. The IRS uses data from these projects to develop more comprehensive projects and allocate its audit resources in the areas showing significant noncompliance.
Just in case your current yacht broker or CPA has not already brought this to your attention, or is still talking about tax benefits from chartering your yacht, here is the IRS CIP of Yachting,
Source: Internal Revenue Service, February 2012:
Yacht-chartering activities
Taxpayers targeted:
Yacht-chartering businesses filing Schedule C, especially with reported losses. The IRS is also auditing partnerships and corporations in this project.
Notable information:
The development of this CIP was based on a case decided, in U.S. Tax Court . The court found that the taxpayer was not engaged in for-profit trade or business from yacht chartering and was ordered to pay approximately $295,000 in taxes and approximately $59,000 in accuracy-related penalties.
To see how your yacht charter business might withstand IRS scrutiny, we strongly suggest anyone claiming tax benefits from their yacht charter business should follow up.
In case your yacht broker, salesman, CPA, or other advisors have not discussed these yacht charter issues, the IRS makes it easy for yacht owners to know exactly what to expect.
The IRS uses Yacht Charter Activities as a specific example to train their auditors.
For starters, here's an Information Document Request (IDR) for yacht owners under audit.
Every boat owner claiming tax benefits from yacht charter activities should be prepared to provide this information – at any time - just as a starting point. There's a lot more to it but here's the basic IDR for boat charter activities.
Appendix E - Example of an IDR for a Yacht Charter Activity
Below is a listing of possible items an examiner might request to assist in determining if a yacht charter activity is an activity engaged in for profit. Some of the items would best be answered in a face to face interview. Examiners should tailor IDR’s to the specific taxpayer under examination.
1. Statement of taxpayer’s boating experience.
2. Copies of experience profiles submitted by potential charterers.
Note to examiner: Is this a crewed charter where the yacht comes with a permanent captain and cook? Or, is this a bareboat charter where the charterer captains the yacht himself?
3. Purchase agreement, Bill of Sale and Invoice, and all canceled checks showing verification of yacht purchase.
4. Statement of actions taken to investigate boat chartering business before entering into this business.
5. Name and address of all charterers and their lease agreement.
6. Schedule of fees or charges billed to charters.
7. Copies of original loan agreements/promissory notes on financed portion of property.
8. Insurance policy(s) on yacht and its contents (collision and liability).
Note to examiner: Does policy cover rental of boat? Is it a commercial or personal asset?
9. Copy of First Preferred Ship Mortgage.
Note to examiner: The Preferred Ship Mortgage provides the financier of a vessel competitive status among competing claims that might arise against a vessel. The lender of an ocean vessel, if eligible, secures a loan with a Preferred Ship Mortgage. Otherwise, in a foreclosure situation the lender will be ranked first among the various maritime creditors that may be competing to collect on a vessel’s proceeds.
10. Promotional materials and charter sailing brochures for yacht.
11. Invoices and ad copies for advertisements on availability of yacht for rental.
12. Copies of any management agreements or management contracts for boat supervision, maintenance, or operation.
13. Ships log(s) for engine and/or boat use.
14. Maintenance records and service check performance records.
15. Certificate of Origin.
16. Certification of Documentation from U.S. Coast Guard.
17. Copy of commercial captain’s license.
Note to examiner: Is potential charterer required to provide taxpayer a copy of their captain’s license?
18. Shipping document or other record which verifies delivery date of property.
19. Copy of any prospectus, private placement memorandum or other promotional material received when yacht was purchased.
20. Yacht operating budgets.
21. Break-even point calculations for chartering activity.
22. All books and records pertaining to the boat business.
23. Copies of your federal tax return for XXXX though XXXX (including any amendments thereto).
24. Please, complete the attached “Statement of Supplementary Examination.”
25. Please complete a Schedule of Boat Use and Schedule of Taxpayer/Shareholder/Partner Time Spent to Operate the Activity of Boat Chartering.”
Page Last Reviewed or Updated: 03-Aug-2012
How do you stack up? Are you ready? Remember, that is just the initial document request.
Pre-packaged charter boat business plans that don't fit your situation are problems. One size does NOT fit all.
And that's just to start. There are many other problems with pre-packaged offerings that boat owners should be aware, but that are too numerous to explore in detail here. Those are subjects best addressed in confidential consultations with competent tax professionals- representing you and NOT the seller of the boat or promoter of the plan.
Of course, you don’t have to worry about proving your yacht charter interests are a legitimate business as most if not all of these audit risks go away and you probably won’t be audited, if your yacht charter business actually does make a substantial profit.
In fact, wouldn’t you prefer your yacht activities actually earned a profit rather than just provided some temporary and questionable tax deductions?
If you answered YES, that’s where we can help. We can apply our proprietary proven corporate and banking strategies and structures to make almost any yacht charter activity significantly more profitable.
As professional advisors to corporate executives, entrepreneurs and now yacht executives, Yacht Executive Solutions is specifically designed to help our yacht owning clients maximize their net worth, which includes proprietary strategies to build their yachting activities into highly profitable enterprises – which may also help preserve any tax advantages as well.
If you have any questions or concerns about your yacht charter activities complying with IRS regulations or would like to learn how we can make your yachting ventures more profitable, please contact us for a confidential assessment and review.
That if your current advisors knew, surely they'd have told you already- wouldn't they?