I know what you’re thinking:
“Um, dude, we’re here for Flying. Why are you talking about taxes?”
Sadly, taxes affect far more of our lives than we’d like to admit. Companies run the way they do because of taxes. Everything about personal finance from savings, to retirement accounts, to how we structure aircraft ownership is based on tax law.
Like most things in aviation, you have to understand a system before you can operate effectively within it, so here we are discussing taxes.
I know many of you will find this discussion a bit basic. Unfortunately, financial education is sorely lacking in the U.S. We’re going to start at the bottom and build up a common knowledge base to make sure any aviation enthusiast can follow along.
What do you answer when someone asks how much fuel your aircraft burns? If it’s anything other than “it depends,” your answer may not be very accurate.
When I’m flying the Airbus A220, I burn roughly 6,000 pounds per hour (pph) in climb, 3,600 to 4,000 pph in cruise, and less than 2,000 pph in descent. For our piston pilots, 6,000 pounds is roughly 900 gallons. (Yes, those numbers are similar to aircraft like the CRJ-900, except we carry 30 to 60 more passengers in far greater comfort. It’s a fantastic jet!)
While most of my legs are in the 2-to-4-hour range, some are so short that I’m only at cruise for a few minutes before I join the arrival and start descending. If I told someone that the A220 always burns 4,000 pph, I’d be giving them a wildly inaccurate impression of that aircraft’s performance. The only way to get an accurate impression of A220 fuel consumption is to consider varying performance in all phases of flight.
It turns out that the U.S. tax system is similar. I encounter a lot of people who simply don’t realize how they’re taxed, and find that some of them make bad, or at least inefficient, decisions as a result. Let’s consider some similarities between the U.S. income tax system and my A220′s varying performance profiles.
The U.S. tax system uses brackets. People say things like: “I’m in the 32 percent tax bracket.” While this statement is correct, it leads to misunderstandings. Some people think that if you’re in the 32 percent tax bracket, that means $0.32 of every dollar you earn goes to taxes. This is wrong. It’s like saying, “The A220 burns 6,000 pph” without providing any further context.
To unravel this, let’s take a look at the tax brackets for 2021:
|10 percent||Up to $9,950||Up to $19.900|
|12 percent||$9.951 to $40,525||$19,901 to $81,050|
|22 percent||$40,526 to $86.375||$81,051 to $172,750|
|24 percent||$86,376 to $164,925||$172,751 to $329,850|
|32 percent||$164,926 to $209,425||$329, 851 to $418,850|
|35 percent||$209,426 to $523,600||$418, 851 to $628,300|
|37 percent||Over $523,600||Over $628,300|
If a single pilot’s taxable income this year was exactly $9,950, then they would pay 10 percent for a grand total of $995 in taxes. If their income was exactly $86,375, they don’t pay 22 percent on that entire amount. Instead, she pays the rate shown in each bracket for the portion of her income that falls within those limits.
For her income that falls into the 12 percent tax bracket, we get:
$40,525 – $9,951 = $30,574
$30,574 x 12% = $3,668.88
And here’s how things look for the portion of her income within the 22 percent bracket:
$86,375 – $40,525 = $45,850
$45,850 x 22% = $10,087
All told, her total tax bill will be:
$995 (from the 10 percent bracket)
$3,668.88 (from the 12 percent bracket)
+ $10,087 (from the 22 percent bracket)
$14,750.88 (total tax bill)
If we divide her total tax bill by her taxable income, we see that her overall effective tax rate is only 17.1 percent, even though she’s “in the 22 percent bracket.” If she made more money, we’d follow a similar process by calculating a tax bill for each bracket in which she had income.
Knowing this, we can calculate the maximum amount of tax that can be paid in each bracket:
|35 percent||$109,961||$180, 895|
Once we arm ourselves with this knowledge, we can make better decisions.
Instead of taking too much fuel because we planned to burn 6,000 pph during climb, cruise, and descent, we can carry less fuel. This lets us fly more efficiently, go further for the same fuel load, and/or save money overall.
The same goes for taxes. Now, instead of expecting to pay the rate of our top tax bracket for everything we make, we realize that we have more money to put toward other things. We can use it to pay down debt or build up investments.
This seems like a simple principle, but it trips up a lot of pilots. Next week we’ll look at some other tax rules that can influence our decisions and hopefully save even more money.
Jason Depew flies as a captain for a major U.S. airline. He is also an Air Force reservist and has flown more than 300 combat missions over Afghanistan and other garden spots. Based in Tampa, Florida, he instructs in the Icon A5 and anything else he can get his hands on. His writing is focused on personal finance for pilots with the goal to help all types of aviators enjoy great careers, sometimes in spite of themselves.