Earning a higher income can mean paying more in taxes at both the federal and state levels. Graduated tax rates at the federal level – and sometimes even the local level – take a larger chunk of your income up the income ladder. But by familiarizing yourself with the rules, you can optimize your tax strategy to save more of your cash. Similarly, a financial advisor can help optimize your financial plan to mitigate your taxes.
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Having a high income can be relative for a lot of people because it means something different based on where you live and your unique situation. High-income earners are typically people making $500,000 or more each year. However, it’s possible that you could technically fit the IRS definition of a high-income earner without realizing it.
The IRS defines a high-income earner as any taxpayer who reports $200,000 or more in total positive income (TPI) on their tax return. Total positive income is the sum of all positive amounts shown for different courses of income reported on an individual tax return.
Your federal tax bracket represents the percentage of tax you owe to the IRS based on specific ranges of your taxable income. Your taxable income is your adjusted gross income, less the standard deduction or any itemized deductions you claim.
For both the 2023 tax year as well as 2024, the highest possible tax bracket is 37%. This bracket applies the taxable income of single filers that exceeds $609,350 ($578,125 in 2023) and married couples filing jointly that exceeds $693,750 ($693,750 in 2023).
Reducing your tax bill when you earn a higher income generally doesn’t mean applying just one single approach. Instead, there are multiple tactics you can use to try to trim your bill. Some of these you can do yourself while others might require the help of your financial advisor to execute. Here are some of the best ways to reduce taxes for high-income earners.
Maxing out tax-advantaged accounts can help to reduce your taxable income for the year. The less taxable income you have to report, the easier it might be to move down a tax bracket or two. Some of the accounts you may consider maxing out include:
Remember that if you’re 50 or older, you can also make catch-up contributions to workplace plans and IRAs. Catch-up contributions are allowed for HSAs beginning at age 55. Also, keep in mind that the amount of traditional IRA contributions you can deduct will depend on whether you’re also covered by a retirement plan at work.
Roth IRAs allow for 100% tax-free qualified distributions in retirement. If you’re a high-income earner, you might not be able to make a contribution to a Roth IRA if you earn above a certain amount. You can, however, convert traditional IRA assets to a Roth IRA.
You would need to pay tax on the conversion on that year’s tax return. But going forward, you’d be able to make qualified withdrawals from your Roth account without paying income tax on those distributions. You’d also be able to avoid taking required minimum distributions beginning at age 73.
A 529 college savings account is a tax-advantaged vehicle that’s designed to help you pay for education expenses. The money you deposit isn’t deductible at the federal level, though some states may offer a tax break for 529 contributions. But the money in the account grows tax-deferred and withdrawals are tax-free when used for eligible educational expenses.
Contributing to a 529 may not affect your current income tax situation but it can help when it comes to estate tax liability. For example, you can contribute up to five times the annual gift tax exclusion limit at once to a 529. Doing so would remove those contributions from your gross taxable estate.
One of the most popular tax-saving strategies for high-income earners involves charitable contributions. Under IRS rules, you can deduct charitable cash contributions of up to 60% of your adjusted gross income. Deductions for contributions of non-cash assets are capped at 30%.
There are a few ways to take advantage of charitable deductions, including:
The last option is something you might consider if you’re age 73 and want to delay RMDs from a traditional IRA. IRA owners over age 70.5 can donate up to $100,000 per year through a QCD, which can help minimize taxable income. Keep in mind that you don’t get to claim this same amount as a charitable deduction. And if you’re deducting donations of cash or non-cash assets you’ll need to itemize them on Schedule A.
Some investments may be more tax-efficient than others and it’s important to ensure you’re allocating assets in the right places. For example, it generally makes sense to keep more tax-efficient mutual funds and exchange-traded funds (ETFs) in a taxable account while reserving higher tax-impact funds for your 401(k) or IRA.
You might also consider investing in tax-exempt municipal bonds as a means of reducing taxes. Interest income from these bonds is excluded from Medicare surtax calculations and it isn’t subject to federal income tax either. Muni bond income may also be free of state income tax.
Also, remember that tax-loss harvesting is your friend. Harvesting losses means selling off investments at a loss to offset the capital gains in your portfolio. You can also deduct up to $3,000 in losses against your regular income. Any losses you don’t harvest in the current tax year can be carried forward to future years.
Certain investments can help you to defer taxes when you earn a higher income. For example, cash-value life insurance allows you to accumulate cash value in your policy. The money that accumulates grows tax-free. Withdrawals are not taxed when they don’t exceed the total amount of premiums you’ve paid.
Annuities may be another part of your tax management strategy. With a deferred annuity, for example, you purchase the contract with payments scheduled to begin at some future date. Meanwhile, the value of the annuity grows tax-deferred. You’ll pay income tax on withdrawals later but this strategy could pay off if you expect to be in a lower tax bracket by the time you retire.
If you own a home with a mortgage, you can deduct the interest paid. Deductions are also allowed for state and local taxes on the property. Deducting these expenses might not make a huge difference to your tax bill but every penny counts for reducing your taxable income.
You can also deduct medical expenses in excess of 7.5% of your adjusted gross income if you itemize. That could be a valuable deduction if you had significant medical expenses to pay for yourself or a member of your household during the year.
Applying tax-saving strategies for high-income earners could help you to owe less to the IRS each year. It’s important to keep in mind, however, that the tax code is always changing. So what works this year might not be as effective – or even possible – three or five years from now. Regularly reviewing your tax situation can help you avoid missing out on opportunities for savings.
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Rebecca Lake, CEPF®Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children. Rebecca also holds the Certified Educator in Personal Finance (CEPF®) designation.
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