HOW CAN PILOTS PAY LESS IN TAXES? PART 2: THINK BEYOND ONE YEAR

Tim: [00:00:00] You’re listening to The Pilot’s Portfolio, the show dedicated to guiding professional pilots towards a future of financial success and stability. Fly along with your host, Timothy P. Pope, as he provides financial planning insights and answers to your burning questions, and dives into real-life stories from fellow pilots who share their successes and cautionary tales.

The Pilot’s Portfolio takes off now. Welcome back to this episode of Pilot’s Portfolio. We are doing a part two. Last episode, we talked about taxes. Something that we hear a lot is our clients, they’re seeing the tax return. They’re realizing, “Hey, we’re paying six figures in taxes,” and that’s like a punch to the gut, right?

Like, there must be something that we can do. So in our last episode, we talked about evaluating where the income is coming from, evaluating what you can do to control it, and why there may or may [00:01:00] not be a magic deduction that you can take. So really trying to understand what all factors come together to influence your tax return.

So we’re jumping into part two and continuing our tax conversation. So my name is Timothy P. Pope. I’m a certified financial planner specializing in the planning needs for professional pilots and principal here at 360 Aviation Advisors, where we help successful professional pilots plan with a well-rounded focus on retirement, investment, and tax planning.

So we help our clients plan for and navigate life’s inevitable transitions. So let’s pick this back up where we left off on the tax talk, and we’re gonna start with talking about investments here. At least for this section, when I talk about your investment portfolio, I’m really talking about your brokerage account, right?

So you’re already doing your 401. You’re getting your NEC. You’re doing your backdoor Roth, and now you’re looking for other places to invest, and in comes your brokerage [00:02:00] account. What we want to think about with your brokerage account is tax efficiency. That is the name of the game. A lot of folks, when they look at the investment per-performance, they’re like, “Hey, was I up eight percent?

Was I up 12%?” That kind of thing. And I say, I didn’t create this, but I’m stealing it ’cause I believe it. It’s not what you make. It’s what you keep. It’s what you keep after taxes. And so when you think about tax efficiency, are your investments paying out more dividends and capital gains than they need to?

Meaning if you’re buying and holding, are you getting penalized because your portfolio is not set up in a most tax-efficient manner? Some of the things that you can look at is your dividend yield. You can look at your SEC yield. You can see how many capital gains your funds, if you’re invested in mutual funds, are generating for you or how many dividends your ETFs are generating for you.

And together, that’s gonna really influence, like, hey, if this is a really tax-efficient portfolio, I can invest. I [00:03:00] can take my lo- my embedded long-term capital gains, and then at a time that is right for you, you can go sell those and pay your long-term capital gains rate, which is preferable, right? It’s 15 or 20%, not your 24 or 32 or higher, you know, that you get with your marginal rate.

So that’s what we wanna think about with a tax-efficient portfolio is, hey, is this tax efficient? I’ll tell folks too, if, if they’re just starting a brokerage account, I’ll say, “Look, let’s be careful how we build it,” because what may start $50,000, $100,000, right, in a brokerage account compounds over time. So the bearable tax inefficiencies that we see that ends up on our 1040 when we didn’t even sell anything that year, it’s bearable.

But as that account grows, you keep feeding it, the market is gonna compound it, then it becomes a real problem. So with your brokerage account, tax efficiency is going to be the name of the game. So continuing the idea of a tax-efficient brokerage account, let’s [00:04:00] talk about tax loss harvesting for a moment.

You’ve probably heard about tax loss harvesting. You may have read about it. You’ve heard it on podcasts. And it’s the idea that all of your investments are not gonna move in lockstep together usually. Some are gonna go up, some are gonna stay kinda shallow, some are actually gonna go down. And when we tax loss harvest, we can take some losses that are in the account, and we can offset those capital gains that we might generate.

Or we can at least lock in some of the losses and then reinvest the money elsewhere. And so we have these embedded losses that we could then use at a time that is appropriate for you. So I do wanna get this– be clear about this, right? The goal with tax loss harvesting is not to lose money. Let’s say last year, broadly speaking, US markets were up 17%.

Okay, so I want, if I’m 100% stock portfolio investor, I’m gonna want 17% or more. But how valuable would it be if in my pursuit to get the 17%, that [00:05:00] I can also generate some losses along the way in my portfolio, and they could just sit there on the side until I need to go sell in my account? That’s the idea with tax loss harvesting.

And then the other thing is, there’s about 200 trading days here in the US. And so a lot of times, you know, Q4 will come around. Folks will talk about tax loss harvesting. I’ve talked about tax loss harvesting in Q4 because people are thinking about taxes or at least tax planning, right? But there’s 200 trading days in the year.

And so tax loss harvesting is not this idea of let’s bunch it up into one quarter. It needs to be happening throughout the year. And I’ll be honest, like, good tax loss harvesting is probably hard to DIY. The scale, the systems, the programs. When you’re out flying, somebody needs to be looking at the account.

There’s systems for that, right? So it’s really hard for good tax loss harvesting to do that DIY. But when you’re thinking about brokerage accounts, or at least when I’m thinking about brokerage accounts for clients, I am thinking about tax loss harvesting [00:06:00] program because typically of where our clients’ incomes are, where their tax brackets are, and the tremendous benefit of, hey, if I can pay- 15 or 20% on my long-term capital gains, that’s great.

But if I were able to generate some losses to offset those long-term capital gains and then actually pay even less, that’s even better. So moving away from your brokerage account, like your investments, I start there because that’s something that most people are very familiar with. You have one, and it’s something that you can start doing right now to influence your tax liability.

But the other thing I want to encourage you to do is think about your tax situation more than one year at a time. I actually laugh at myself for telling you to do that because I know your lives are busy. You fly for a living, you’ve got families, you do all these other things. But if you can think about your tax life more than one year at a time, that, I think, will pay really big dividends.

And here’s the reason. Most folks just say, “Hey, you know, we paid [00:07:00] six, you know, we paid six figures last year. What can we do this upcoming year to reduce?” I’ve already told you. I told you on the last episode, I probably told you at the beginning of this one, I think that’s the wrong target is the one year.

We really need to be thinking about this over time, over the next twenty years, thirty years kind of thing. Because your financial life compounds to the decisions that you make today, compounds, it impacts what happens tomorrow, and the same thing is true for your tax burden. So if you can look at it in more than a single year, I think that’s better for you.

Now, you may not have the software, you may not have the expertise, right? You probably don’t wanna read IRS publications or rules. I get it. That’s cool. For most people, that’s not interesting. But here’s what you can think about The financial life cycle of a professional pilot has a specific rhythm, right?

So early years, probably gonna be your lower income years, even if you’ve moved from military, went back down to year one, you’re seeing a lot more taxable income. Your tax bill is higher than it has been. Still gonna be some of your lower income years likely. [00:08:00] Then you upgrade to captain. Then you, maybe you go to wide body.

Then maybe you have the ability to select, you know, fly more premium trips, right? Once your, your seniority is in a spot that you like it. So all of that you can see as your income is building until eventually you get to your peak earning years. Then you retire. So right now, 121 World, you’re gonna retire at 65 or sooner.

So that’s a couple of years before full Social Security kicks in at 67, and that’s 10 years before required minimum distributions kick in at 75. If you’re military, eventually you’ve got pension, you’ve got Social Security, you’ve got those required minimum distributions. All are gonna be taxable. So you can see that there’s this kind of curve, almost a bell curve really.

Well, the end of it might not come back down to the beginning, and if you plan right, it usually doesn’t. So you’ve kind of got this curve of your financial life cycle. And so when you think about, when I encourage you to think about your taxes more than one year at a time, you wanna ask yourself these questions: [00:09:00] What are your highest tax years likely gonna be?

Where are your lowest tax years likely gonna be from this point on? If it was behind you, there’s not much we can do about that. What decisions or tools are available to you? So you got your 401, you got your backdoor Roth, you got your HSA, you got your pre-tax contributions. A lot of you guys now have your market-based cash balance plan, American Delta, Southwest market-based cash balance plan.

You’ve got deferred compensation as well. What, you know, tools does your spouse have if your spouse works? What alternative investment do you wanna get into? All of those things we ask to help you think about, hey, more than one year at a time, ’cause this year we might do something that makes you write a little bit more in taxes, but in a future year it’s gonna be substantially lower, and that’s the whole name of the game.

Again, I laugh because it’s easy for me. I have all the software, I have the training, I’ve got all the tools, right, to say, “Hey, like, do some multi-year projections of your tax return.” In my experience, that does not excite most people. But that’s why we’re here, so you can [00:10:00] give us a call on that. So what does tax planning actually look like?

So we talked about some strategies that you guys could do. I gave you some life benchmarks to look at to kind of think about the financial life cycle of a professional pilot. So what is– how do we use this information? So when we think about tax planning, number one, obviously, we’re gonna look at the past previous returns.

We wanna know what created the income, what changed, what came from things that we can control, like non-wage and income, and then what were things that are outside of our control. Like, so you just wake up, fly the airplane, and then that’s the income that you have. And we’re really gonna wanna focus in on the things that we can control.

So, like, can we– are there income sources that we can control its timing? Are there deductions that you did take advantage of or that you did not take advantage of? Tax planning is we’re really gonna look forward. What is likely to change? How much more do you have in your current bracket if you are in the twenty-two percent or the twenty-four percent?

I think the twenty-four percent is a really good example. [00:11:00] If you’re close to filling up the twenty-four percent but not quite, but maybe you’ll fill it up In the next year or two, the next stop after twenty-four is thirty-two, and once you leave the twenty-four, you’re probably not coming back to the twenty-four for quite some time unless it’s after retirement.

And so is there anything that we can do to take advantage of filling up the twenty-four percent bracket? So we think about tax bracket management. We already talked about earlier in today’s podcast about being careful with your investment bro-portfolio, your brokerage portfolio, tax loss harvesting, making sure that we use a tax-efficient portfolio.

We minimize short-term capital gains. We minimize ordinary income coming in from those investments, and we maximize our long-term embedded long-term capital gains. Also, with planning, we talked about backdoor Roths, a WATT, but you guys have access to 401plans that will support mega backdoor Roths. So hey, you put in your, you know, your seventy-five hundred or your eighty-six hundred, depending on your age.

Is there space left in your 401to go [00:12:00] back and do a, an after-tax contribution? And I’ll tell you, United is pretty good at this. They will– at the end of the year, they will send out an email to you guys and say, “Do you want to top up your 401contribution, like, with an after-tax?” That’s pretty neat. I haven’t seen that from the other carriers, but things like a mega backdoor Roth contribution is another part of tax planning as well.

All right, so now I want to give you guys a couple of questions to ask yourself. So hey, we’ve paid six figures in taxes last year. We’d like to get it down. I’ve listened to Tim’s podcast. I’m understanding that I should be thinking about multi-year tax planning versus one year at a time, because I think that I’m going to get the biggest bang for my buck that way.

So what should you be asking yourself, right? So number one, when you look at your income, what part of your income is controllable? Is some of this just from waking up, flying the airplane, or did you trade extra? Did you sell something? Did you inherit an IRA, and now you’re in the inherited RMDs phase for the next ten years?

Like, what [00:13:00] can you control? Number two, are we reducing tax, or are we simply deferring tax? All right, there’s a big difference. If I’m deferring it, I’m gonna end up having to pay that later. If I reduce it, that means, you know, I’m paying a less effective tax rate overall. Those two do not take the same strategy usually.

There’s a difference between them, and I think just getting clear on which one you want to do. What I tell folks is, “Hey, let’s focus on lowering the lifetime taxes.” So we give deference to the future. We, we don’t know what Congress is gonna do. We don’t know what your future’s gonna look like. But with reasonable presumptions or projections there, we’d like to lower our lifetime.

Question number three. Are your brokerage investments being managed with taxes in mind? Is it tax efficient? Do you have unnecessary dividends and capital gains being spun out to you? Are you practicing tax loss harvesting, not just to create a loss in your account, like we’re not interested in losing money, but to manage the portfolio to improve your after-tax returns?

So that’s what we’re after. [00:14:00] Question number four. Are you building flexibility across different account types? We didn’t talk about that in detail here. You’ve probably heard it in other episodes of the podcast. But if you got your brokerage, you got your traditional, you have your Roth, those are going to give you three different tax treatments.

And we might do a deep dive in a future episode, but three different tax treatments to improve your flexibility when you need cash from your own portfolio. Okay? So are you building the flexibility across your different account types? And then the fifth question, are you planning for this year’s tax return, or is your goal to lower your overall tax burden across your life?

And I would put forward to you to let that drive your tax strategy, right? To lower your overall tax burden across your life, and then partner that with your own financial goals. Some people prefer to pay less tax, pass it on to the kids if they’re planning to inherit. Others say, “Hey, look, no, I’ll rather take a little bit more of the hit [00:15:00] and pass the tax-free income to the kids.”

Right? So whatever is important to you, let that be your driver, and then let the tax strategy just enhance those decisions. So that’s gonna do it for this episode, guys. As always, huge shout-out to our friends at Beacon Relocation. Guys, if you’re thinking about buying or selling this season, give them a call.

And if you’re in the Charlotte area, you have the opportunity to work with some of the founders, which are super awesome. My family’s been working with them recently. So give them a call. But that’ll do it. Stay safe, guys, and we’ll see you on the next episode. Thank you for joining this episode of Pilot’s Portfolio.

If you found this information helpful, spread the word and share it with a pilot buddy. Or if you have questions and there’s something that you would like to hear discussed on the show, send us an email. You can find the address in the show notes. For those of you who are ready to learn how we help professional pilots with their financial planning needs, [00:16:00] schedule an appointment.

Until next time, keep the shiny side up, and we’ll see you on the next episode Pilot’s Portfolio is hosted by Timothy P. Pope. Timothy P. Pope is principal owner of 360 Aviation Advisors. 360 Aviation Advisors is a registered investment advisory firm regulated by the state of North Carolina in accordance and compliance to the securities laws and regulations.

360 Aviation Advisors does not render or offer to render personalized investment or tax advice through Pilot’s Portfolio. The information provided is for informational purposes only and may not be suitable for all investors and does not constitute financial, tax, investment, or legal advice. All investments involve a degree of risk, including the risk of loss.