IRS: Airline baggage fees not taxable as transportation, security fees are taxable

Just when you think you have heard it all, a part of the government comes up with a new head-scratcher. This time it is the IRS announcing that the baggage fees that the airlines collect from passengers are not considered taxable transportation, while the government-imposed security fees are.

A few business magazines and some blogs have commented on this “non-taxable” ruling. But upon further examination, baggage fees are taxable, just not as transportation. It appears that taxes are eventually collected from the airlines for these fees as overall corporate profits and passengers may actually benefit from not having 7.5 percent transportation federal excise tax slapped on the baggage fees.

Unfortunately, the government imposed security fees are taxed as transportation; adding insult to injury.

Let me confess immediately that I am not a tax expert and have only gathered my information for this post from the IRS Tax Code, Section 4261 and from the IRS Tax Ruling that was sent to American Airlines who requested clarification of the tax code as the airline continues its aggressive “unbundling” of airfares.

I also went through the ticketing process to see just what taxes are passed on to passengers as part of the ticketing process.

The most interesting portion of this relatively obscure tax clarification, from my point of view, is that a baggage fee included in the airfare and therefore paid by everyone, whether they check baggage or not, is a taxable transportation event.

However, when the baggage fee is unbundled and only charged to passengers who “choose to check luggage,” the fee becomes optional and is not considered a requirement for transportation; hence, it is not taxable “as transportation.”

Of course, the airlines are collecting these fees and moving these monies right to their bottom lines these days in the multi-billions of dollars of revenue as reported by the Department of Transportation. These billions in baggage fees will eventually be taxed as corporate profits come corporate tax time.

Here is the first portion of the relevant IRS regulation:

Sec. 4261. Imposition of tax

(a) In general
There is hereby imposed on the amount paid for taxable
transportation of any person a tax equal to 7.5 percent of the
amount so paid.

We passengers pay those taxes whenever we purchase an airline ticket. We also pay the taxes whenever we pay for anything “as a condition to receiving air transportation.”

The IRS ruling specifically for baggage follows:

Section 49.4261-8 provides examples of payments for services not subject to the § 4261(a) tax. As relevant herein, § 49.4261-8(f)(1) provides that the § 4261 tax does not apply to charges for transportation of baggage, including incidental charges such as excess value, storage, transfer, parcel checking, special delivery, etc.

I think this actually saves passengers the 7.5 percent transportation tax that would otherwise be imposed.

In the case of security fees, the IRS found they are taxable. Why? Because, without paying the security fee the passenger cannot board the aircraft for transportation.

For Services that are not addressed by the regulations, IRS published guidance limits the tax base to amounts paid for mandatory charges; in essence, amounts that must be paid to get on the airplane. Rev. Rul. 73-508, 1973-2 C.B. 366, for example, holds that a security charge is part of the amount paid for taxable transportation because it is required to be paid as a condition to receiving air transportation.

This 7.5 percent Transportation Excise Tax is charged to passengers, not the airlines. Here is an explanation of taxes added to airfares.

For domestic travel within the Continental United States:
U.S. excise tax of 7.5% based on the base fare;
Passenger Facility Charges of up to $9.00 each way
September 11 Security Fees of up to $5.00 each way
Federal Segment Tax of $3.70 per domestic segment. A segment is a takeoff and landing.

For me the most interesting part of this ruling was the original letter from American Airlines requesting the IRS ruling on their additional fees and charges as the airline unbundles its airfares.

Those will be added as a separate post and linked to from this post.