Earning a higher income can mean paying more in taxes at both the federal and state levels. You might assume that you’re stuck with a bigger tax bill because you earn more but that’s not always the case. There are a number of tax-saving strategies for high-income earners that can help to reduce what you owe. The key is knowing which ones to implement, based on your specific financial situation. A financial advisor can help optimize your financial plan to mitigate your taxes.
What Is a High-Income Earner?
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.
That’s important to understand because you might assume that high-income earners are people making $400,000, $500,000 or more each year. It’s possible that you could technically fit the IRS definition of a high-income earner without realizing it.
Finding Tax Deductions for High-Income Earners
Understanding where you are income-wise matters when applying tax-saving strategies for high-income earners. Certain tax breaks begin to phase out the higher your income climbs. It’s also important to know which tax bracket you fall in.
Your federal tax bracket represents the percentage of tax you owe to the IRS based on your taxable income. Your taxable income is your adjusted gross income, less any personal exemptions and itemized deductions you claim. In order to find the right deductions you’ll have to make sure that your income allows you to take those deductions.
For the tax year 2023, the highest possible tax bracket is 37%. This bracket applies to single filers with taxable income in excess of $578,125 ($539,900 in 2022) and married couples filing jointly with taxable income in excess of $693,750 ($647,850 in 2022).
Tax Saving Strategies for High-Income Earners
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.
1. Fully Fund Tax-Advantaged Accounts
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.
2. Consider a Roth Conversion
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 at the time that you complete it. 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 72 (73 in 2023).
3. Add Money to a 529 Account
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 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.
4. Donate More to Charity
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:
- Making a cash donation directly to an eligible charity
- Donating appreciated non-cash assets, such as stocks, could allow you to avoid the capital gains tax
- Establishing a charitable remainder or charitable lead trust
- Setting up a donor-advised fund
- Taking a qualified charitable distribution (QCD) from an IRA
The last option is something you might consider if you’re age 72 or older (73 in 2023) 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 to reduce 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.
5. Review and Adjust Your Asset Allocation
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 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 bonds 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.
6. Consider Alternative Investments
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.
7. Maximize Other Deductions
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.
The Bottom Line
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.
Tips for Financial Planning
- Consider talking to your financial advisor about the best ways to minimize your tax liability as a high-income earner. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- One more tax planning strategy you can try involves deferring part of your income. For example, if you’re scheduled to get a big year-end bonus, you could ask your employer to hold off on paying it out to you until January. Just keep in mind that deferring income to future years could rebound if it ends up pushing you into a higher tax bracket later.
©iStock.com/simpson33, ©iStock.com/kazuma seki, ©iStock.com/Inside Creative House