The top 10% of high income earners in the U.S. pay anything from $108,251 to $653,720 in federal and state income taxes. It’s also the top 50% of taxpayers that foot the bill for federal government funding, contributing a whopping 98% to the coffers. Naturally, the question of how tax liability can be reduced becomes a focal point for high income earners. [1]
In this article, we take a look at how proactive tax planning can help you manage the amount of taxes you hand over to the IRS and state departments. We also consider what lawmakers have in mind by 2025 and beyond for America’s wealthiest citizens.
You can rescue some of your taxable income from going to government spending with legitimate strategies for high income earners. This will require the help of an accountant familiar with tax legislation pertaining to allowable deductions, credits, capital gains tax, property taxes, and investment income.
Hall Accounting Company provides tax planning and preparation services as part of a greater wealth management portfolio, to high income earners. Schedule an initial consultation today, and let’s discuss how we can help you put your income into things that matter to you.
What does the IRS consider high income earners?
The Internal Revenue Service classifies a high income earner as someone who earns over $200,00 as their total positive income (TPI). Put another way, you would be a taxpayer in brackets 5, 6, or 7 as dictated by the IRS. As a married person filing jointly, you are considered as high income when you make more than $383, 901 annually.
How does tax planning help you avoid paying high taxes?
By its very nature tax planning must be proactive. It’s about getting to grips with what you’ll be liable for in federal income tax, as well as state and local taxes. Once the total tax liability is well understood, you can go to work with an accountant on tax reduction strategies.
Tax planning may not mean you can walk away with a much larger amount of cash in your bank account, but it will mean you can use your income in a way that benefits you and your family in the long run. Investments, retirement plans, bonds, and a health savings account are just some of the ways you can do this.
We suggest that you speak to your accountant or tax professional before making any final decisions, and if you don’t have one, you really need to get one. We’d be happy to discuss your needs in a telephonic consultation. There are a number of strategies we can suggest that go beyond the generic ones we’re about to cover.
Yes, let’s discuss tax reduction strategies.
10 Tax saving strategies for high income earners
Retirement accounts
Retirement accounts are a great way to keep more of your money with you instead of handing it to the IRS. There are a number of retirement accounts you can use to reduce your tax burden.
A good first step is to maximize your company sponsored retirement accounts such as the 401(k), 403(b), and the 457. By putting additional money into those plans you’ll be reducing your taxable income today. The downside of doing this is that you will have to take the required minimum distributions in your future (age 72 years). This is about balancing today’s actions with tomorrow’s consequences. If you feel you may be in a lower tax bracket at a future date, the risk could pay off and reduce your tax bill today.
If your company offers the Roth 401(k), this is another option. You won’t get tax deductions today, but you will be able to make tax-free withdrawals in the future. This is a good decision to make if you feel like you’ll be in a higher tax bracket at a later date.
Once you’ve maxed out the company sponsored accounts, you can put some money into your individual retirement account (IRA) or your Roth IRA. Just to be clear, these accounts all have maximum thresholds, where you will no longer be able to make contributions.
If your company allows for it, you might be able to make an after-tax 401(k) contribution. By doing this, any additional money you put into the account will grow there tax deferred. You’re deferring the tax on that money to the future.
Investments in Taxable Accounts
A taxable account allows investors to deposit funds and buy and sell investments. You pay taxes on interest, dividends, and capital gains. Capital gains taxes are taxed on a short-term basis or long-term basis.
Where should your focus be with this? On long-term gains. Here’s why. Any short-term gains will be subject to higher tax rates, whereas long-term gains are taxed at a lower rate.
Short-term capital gains taxes: Taxed according to ordinary income tax brackets (10% - 37%).
Long-term capital gains taxes: Taxed at 0%, 15%, or 20%.
Something to consider here is the diversification of your retirement accounts and taxable accounts. Your accountant can help you with this. If you diversify your investments, you can control when you pay federal taxes and how you utilize tax savings.
Tax efficient funds vs. mutual funds
Individual stocks or exchange traded funds are more tax efficient because you are controlling when you’re buying and selling, and therefore the timing of the capital gain tax. In mutual funds, the fund manager is controlling the movement of stocks. All the gains or losses are then passed on to you whether you want this or not. This can have a significant impact on your tax bill.
Health Savings Accounts
Our next strategy is the health savings account (HSA). If your company offers you this benefit, take it. The tax benefits are received in the year that you put the money into the account, reducing your taxable income.
Furthermore, the money grows tax free, and as long as you use the money for qualified medical expenses, you also get to withdraw it, tax free.
Deferred compensation plans
Again, you’ll have to check with your employer whether they offer these plans. This is when a portion of your salary is taken away and invested by the employer, to be paid out at a later date. At the time the money is paid to you, you may be in a lower tax bracket, and therefore your tax liability will be less.
Check carefully whether the compensation is tax deductible and confirm that this kind of plan meets both the requirements of federal and state tax laws.
529 plans
If you don’t want to pay tax today and you have children or grandchildren, you can support them in their college education with a 529 plan. You can defer taxes on dividends, interests, and gains by contributing to the education savings plans, and if the money is spent on allowable expenses, you will never have to pay tax.
At this point, we hope you are finding the information helpful. It is important to remember that the tax code is always changing, so what works in one year, may not work in another. If you don’t have a trustworthy accountant that can help you manage your tax liability, we suggest you invest in these services, so that you don’t have to keep tabs on changing tax codes.
Speak to a Qualified Accountant
Business structure
This one is important if you are self-employed, or an independent contractor. Whether you get taxed as an S-corp, a C-corp, or a sole proprietor, can make a huge difference to your tax liability. State income tax differs significantly where this is concerned, so you should speak to an accountant about your state’s income tax rates.
Life insurance that builds cash value
Life insurance is to provide a death benefit for families of the deceased. Some life insurance policies build allowances for a cash value into them. The cash value of the life insurance earns interest, and taxes are deferred on the accumulated savings. The policyholder can then borrow, or withdraw cash from the policy, or use it to pay premiums. [2]
Invest in real estate
For the most part, we’ve been discussing how you can reduce your taxable income, or defer your tax liability until you are in a lower tax bracket (e.g. retirement). But you could also invest in real estate to maximize tax deductions. Additionally, you may be able to defer paying taxes on any profits with a 1031 exchange. Simply put, this is when you swap out one investment property for another, delaying capital gains tax.
Make charitable donations
One tax deduction that can be of real benefit is charitable contributions. Annual contribution limits according to Schedule A as an itemized deduction is limited to a percentage (usually 60 percent) of your adjusted gross income (AGI).
To qualify for a tax deduction, the contribution must be:
A cash contribution;
A qualifying organization;
Made during a calendar year [3]
Contributions of non-cash property will not qualify for this relief. However, there are a number of non-cash contributions that you can claim, subject to the normal limits.
Not sure which non-cash contributions you can claim? Give us a call today to discuss reducing your tax liability.
Qualified charitable distributions
One way of reducing the amount of money going to the IRS at a future date is related to your 401(k). You are allowed to donate a portion of your 401(k) directly to a qualifying charitable organization. Let’s say you have a required distribution to take at age 72 of $100,000. Instead of paying taxes on the full amount, you decide to donate to charity. You take $50,000 and give it away. Now your taxable income is only $50,000.
This is a way to give to others, and also help yourself by lowering your tax bill.
Gifting
This is a way to reduce taxable income and hand some of your money over to loved ones, like your children. They may be in a lower tax bracket and therefore will pay lower taxes on interest, and dividends. However, this is something that must be carefully considered and weighed for short-term and long-term benefits.
In Conclusion
It’s become pretty obvious at this point that tax planning is not just about getting more money in your pocket today. In many cases, it’s about what you want to do with your money instead of letting the government decide what they want to do with it.
It’s about finding the right balance between paying taxes today and deferring taxes. It’s about when, where, and how you will pay taxes as opposed to never paying taxes. In a CNN post, it was reported that the IRS has collected more than $1 billion in past due taxes from millionaires since last fall (2023/2024). That’s $1 billion that could have been put into retirement accounts, health savings accounts, investment accounts, or given to charity and education. This is an example of how working against the system ended up being detrimental to the millionaires, their families, and the community.
It’s really tough when you’re working hard and you have to give a massive portion of your income to the government (who you may or may not support). However, avoiding the issue comes with consequences that you may not want.
Tax planning is the smart solution for high income earners who want to control where and when they pay taxes, and how their money is spent.
We’ll help you work it all out by diversifying your efforts in the short term and long term. If you’re looking for a partner who understands what you want to achieve, look no further than Hall Accounting Company.
We are ready to discuss these strategies and many others with you. If you don’t like what you hear after the initial consultation, no hard feelings. You’re not under any obligation to work with us.
Let’s work something out together.
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References:
1. CBS News
2. Investopedia
3. IRS