As a high-income earner, tax season is always a reason for great stress. For sure, falling into a high tax bracket means a huge tax liability, and with ever-changing tax laws, it becomes complex and uncertain. The challenge remains to learn and efficiently work out the effective tax reduction strategies that can help manage this liability effectively
Hello, I’m Mark Fonville with Covenant Wealth Advisors. Anyone can be overwhelmed by how complex the tax law is and how it specifically hits high-income earners. Landmark legislation, including but not limited to the Tax Cuts and Jobs Act of 2017 and the Secure Act, makes it very important to understand how one can proactively protect their wealth. In this guide, I will show you strategies that are specifically designed to lower your tax burden using updated tax laws and opportunities.
Knowing one’s tax bracket, availing of the deductions available, and using tax deferral and reduction strategies can go a long way in saving a huge amount in taxes. The key tax-reduction strategies that will be discussed in this post for high-income earners involve deductions, deferrals, and other advanced techniques of tax planning with a view to optimize one’s financial situation.
Tax Laws
Making Sense of Recent Changes
You may have heard of the Tax Cuts and Jobs Act of 2017, which slightly lowered the income tax rates of many brackets. The cuts sunset, in which it increased the amount of the standard deduction both for single and jointly filing persons. This change in the rule has made it a little more difficult for high-income individuals to find and take advantage of their itemized deductions.
In addition were the Secure Act and the Taxpayer Certainty and Disaster Tax Relief Act of 2019. Each further muddled tax strategies. High-income clients have to address a number of changes in several tax-relieving ways. To efficiently lower their taxes, they needed to understand how changes will work.
Tax Bracket Insights
Do you know what bracket you fall into and how much of your income is being taken? The tax rates for high-income earners generally fall between 32% and 37%. Understand how much of every dollar you make is being taxed because this will be the basis for your strategy for reduction.
Deductions
Above-the-Line Deductions
Above-the-line deductions lower your Adjusted Gross Income (AGI), which will help you qualify for more deductions or credits. Above-the-line deductions for high-income earners that you may want to consider are:
- Health Savings Account (HSA) contributions
- Deductible traditional IRA contributions
- Qualified retirement plan contributions
- Qualified charitable donations
Below-the-Line Deductions
Below-the-line deductions are taken after your AGI has already been calculated and can be in the form of either standard or itemized deductions. Most taxpayers take the standard deductions because it is usually a pain in the neck to itemize them. However, if you plan well enough, you can itemize and cut down significantly on your taxes. You should concentrate most on:
- Charitable contributions
- Mortgage interest expenses
- Medical expenses
Income Deferral and Acceleration
Generally speaking, the deferral of income or acceleration of deductions impacts current tax liability immediately. Consider the following:
- Deferral: The deferral of income or retirement withdrawals may be reinvested to compound savings and investments, but there is a possibility that higher tax rates might apply in the future. Review the use of nonqualified deferred compensation contributions and timing for IRA withdrawals.
- Acceleration: Accelerating income or deductions may lower your tax liability in the current year, but this could increase your future liability.
Tax-Deferred Investment Vehicles
These may include, but are not limited to, the following tax-deferred investment vehicles, which can help reduce current tax liability and aid in compounding returns:
- Stock bonus plans
- Vested qualified retirement plans
- Education IRAs and 529 plans
- Cash value life insurance
Other Tax Savings Opportunities
Roth IRA Conversions
Converting traditional IRAs into Roth IRAs may be advisable, especially if your future tax rates will be higher. Although these conversions are subject to income taxation in their year of conversion, they provide tax-free growth and withdrawals during your retirement years.
Tax-Exempt Bonds
Tax-exempt bond investing provides interest income from federal taxes, which is quite helpful for those with high incomes.
Business Entity Restructuring
Restructuring a business entity can sometimes have some advantages concerning taxes, depending on how it’s set up and where the income is coming from. Examples to consider are S-corporations or LLCs for possibly better tax efficiency.
Health Savings Accounts (HSAs)
Investing HSA contributions reduces taxable income while allowing tax-free withdrawals for qualified medical expenses.
Tax-Efficient Index Mutual Funds
Invest in tax-efficient index mutual funds that could, by design and operation, minimize capital gains distributions and hence your resulting tax liabilities.
Managing Large Gains
Large gains management and timing will also help in keeping your tax liability to the minimum. Consider strategies that might apply to offset some gains, such as tax loss harvesting.
Bundling 529 Plan Contributions
Bundling 529 plan contributions offers an opportunity to maximize tax benefits while lowering taxable income in the year of contribution.
Conclusion
Filing taxes can be overwhelming, especially for high-income earners, but knowing and employing some key tax-reduction strategies can significantly lighten the burden. Stay ahead of tax laws, leverage deductions, and explore other techniques in tax planning—the ideal financial strategy that will reduce your overall tax burden. Generalized tax planning addresses each and every aspect of your total financial situation, and working with a tax advisor will help you to move through the complexity.