Many CFIs (and flight crew members as well) may not even be aware of the potential tax savings they can get simply by recording the purchases and expenses they incur while being paid to fly. The tax benefits are equally available to full-time and part-time instructors, and all it takes is a good record-keeping system.
In practice, tax laws differentiate between deductible expenses for an employee and an independent contractor, but the end result can basically be the same, depending on individual circumstances. Employees and independent contractors claim their deductions in different sections of their annual tax returns (1040); however the actual items claimed as deductions will essentially be the same for both groups. A discussion of a few basic concepts will clear up the overall picture.
Employees of a company receive a paycheck at the end of each pay period. From each paycheck the employer withholds money for federal income taxes, based on the actual wage and the number of exemptions the employee claims. At the end of the year, the company gives the employee a Form W-2, which totals the amount the company withheld during the year. This amount is then applied on the 1040 to the tax liability the employee owes for the year.
That tax liability is a percentage (tax bracket) of the employee's "taxable income." Taxable income is computed by figuring an "adjusted gross income" and then subtracting either a standard, or itemized, deductions and the employee's personal exemption. The standard deduction and personal exemption are fixed amounts for various classes of taxpayers, but the government changes them every year to reflect inflation.
The adjusted gross income is the employee's actual before-tax wages. Other types of income, such as bank interest, increase it; and other deductions, such as capital losses, reduce it. These increases and reductions are the "adjustments." The lower the adjusted gross income, the lower the person's tax liability, and vice versa.
Later in this article we'll see how independent contractors can lower their adjusted gross income. Employee flight instructors, on the other hand, can use their work expenses to increase their itemized deductions, rather than reduce their adjusted gross income. Essentially it gives the same result - less tax paid.
Whether achieved through reducing adjusted gross income or increasing itemized deductions, the lower the taxable income, the lower the tax liability. In addition, for employees who have paid money to the IRS through withholding, or employees and contractors who have paid estimated quarterly taxes, lower tax liability could also mean getting a refund check.
To take advantage of the available deductions, a CFI must complete certain "schedules" for their 1040s. A CFI who is an independent contractor should not simply list income on the line for wages or "other income" on the first page of Form 1040. Instead, complete Schedule C - Profit or Loss From a Business.
Schedule C asks for "total receipts," which means gross income earned from instructing. Then comes a large section for listing expenses that reduce the total receipts and give a bottom-line figure. The final figure could be a negative number, and the contractor inserts it in the appropriate line on the 1040. If the number is negative, it will actually reduce total adjusted gross income.
If an instructor simply puts the gross amount earned on the 1040 without reducing that amount for the expenses on Schedule C, it results in a higher adjusted gross income - and greater tax liability. In other words, it means more money to the IRS and less money for the instructor.
Employee flight instructors take a different route, but they essentially end up in the same place - if all the circumstances are correct. An employee might be able to reduce tax liability by increasing itemized deductions, not necessarily by reducing adjusted gross income.
Because taxpayers have a choice between claiming standard or itemized deductions, a taxpayer should only itemize if the total itemized deductions are greater than the standard deduction. For tax year 1997, the standard deduction is $4,150 for singles, $6,900 for married couples, and $6,050 for the head of household. For most individuals, unless they are paying a home mortgage and deducting the interest or had large medical expenses, itemization doesn't result in a deduction larger than the standard deduction.
Even without a mortgage interest deduction, an employee flight instructor would do well to calculate itemized deductions at least. It's surprising how deductible expenses can accumulate. Itemized deductions are calculated and listed on Schedule A of Form 1040. One section allows a deduction for "Job Expenses," that is "unreimbursed employee expenses - job travel, union dues, job education, etc." This is where an employee flight instructor can deduct the expenses incurred while being paid to teach others to fly.
What sort of things are allowed as deductions? Just about any expense related to the business of flight instruction. Common items are navigation charts, flight computers, flight cases, books, teaching aids, video tapes, etc. These are the items a CFI buys and uses in the course of the job. As long as an employer or student is not paying for or reimbursing the instructor for those items, they are deductible.
Here are some other items you may not have thought of, but they have passed the audit test. Uniform expenses - obviously, this applies if the school requires a uniform, but also applies to specialized clothing used in instructing such as a heavy duty jacket or boots purchased for those cold mornings on the ramp. (If you wear the clothing other than while instructing, figure the percentage of time you wear it for instruction and deduct that amount). Dry cleaning expenses for uniforms are also deductible.
Equipment - computers, sunglasses, instrument hoods, computer programs, headsets, intercoms, logbooks, etc.
Miscellaneous - flying club dues, association memberships, magazine subscriptions. You can deduct education expenses only if the education assists you in your current job and does not prepare you for a new one.
For example, if you work as an instructor after earning your CFI, you can deduct the cost of your recurrent training as well as the cost of earning your instrument and multiengine instructor ratings. You cannot deduct the cost of earning an airline transport pilot certificate because, in the eyes of the IRS, an ATP prepares you for a job as an airline pilot.
The recurrent training is required under the federal aviation regulations, so you can continue to teach, and earning your CFII and MEI allow you to teach in additional aircraft and under specialized circumstances. You can also deduct the cost of a college degree, but only if it helps your current job and doesn't prepare you for a new one. That is, a degree in aviation would be deductible and a degree in history would not.
Independent contractors can deduct additional things, such as pens and paper, because they are supplies. An employee cannot deduct these items. Contractors can also deduct the cost of meals eaten while on a dual, training cross-country, so you might want to buy your students lunch once in a while! Employees, however, can't take that deduction. Travel to and from the airport to get to work is not deductible for either employees or independent contractors. Flight instructors can deduct many other items, but these deductions depend on individual circumstances too numerous to list here.
It usually takes a few tries at preparing your own taxes to understand how to get the best savings from CFI deductions. The best way to take advantage of all allowable deductions is to set up a reliable record-keeping system. You might write each day's expenses in a pocket calendar and tally them at the end of each month, just like you might do with your logbook.
Be sure to keep all receipts, and try not to keep them in a shoe box. One instructor I know keeps the year's receipts in a three-ring binder divided by the type of expense - meals, education, equipment, etc. For him, tax time is simple, quick, and well-organized. For additional tax savings ideas, a CFI might also think about visiting an accountant. Depending on the complexity of your return, an accountant might charge anywhere from $75 to $300 to prepare your taxes, but you can deduct this fee.
As a professional flight instructor, you can develop good habits that will carry through your career. Those can be financial habits as well as flying habits. Airline pilots have a reputation for being ? "thrifty." Perhaps they learned that while instructing and by preparing their own taxes during those years.
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