If you are a small business owner, early startup employee, or firm founder, you can end up in a higher tax bracket if your company expands or you receive stock pay gains. However, that does not indicate that you must just put up with a greater tax burden. You can lower your federal taxes as well as your state and local taxes if you follow the correct advice.
We'll explore 20 tax-saving techniques in this post that you can use to reduce your taxable income.
The Definition of a High-Income Earner According to the IRS
There is a little confusion in the IRS definition of a high-income earner. Generally speaking, the industry reports two definitions:
The Tax Reform Act of 1976 mandates the annual reporting of data on individual income tax returns with income of $200,000 or more.
Taxpayers who fall into the top 3 tax brackets which in the 2023 tax year is anyone with income of $182,101 or more.
Wages and salaries, investment income, business transactions, and other sources can all provide revenue. In order to determine which tax bracket you are in as your income rises, it is critical to comprehend what the IRS considers to be income. You can use tax tactics to lower your taxable income or postpone paying taxes by consulting with a tax expert.
20 Strategies to Reduce Tax for High-Income Earners
Tax strategy is complicated, and depending on your circumstances, there are many different strategies to lower your taxable income. When submitting your 2024-2025 taxes, take into account these 20 strategies to reduce tax income for business owners in Honolulu 96816.
1. RETIREMENT CONTRIBUTIONS
People can lower their taxable income both now and after retirement by utilizing a variety of tax-related retirement planning techniques.
Traditional 401(k) and Roth 401(k)
Employees can contribute pre-tax money from their salaries to a Traditional 401(k), which can grow tax-deferred until the money is taken out later in retirement. People in higher tax brackets in their pre-retirement years may benefit from this since it lowers their taxable income in the year they are earned.
Because a Roth 401(k) is funded with after-tax money, contributions—including investment earnings—are taxed before they are deposited into the account, but withdrawals made during retirement are tax-free. For taxpayers who want the assurance of tax-free income in their later years or who expect to be in a higher tax rate in retirement, this could be advantageous.
Traditional IRA and Roth IRA
With a Traditional IRA, people can make contributions that, depending on their income and involvement in an employer-sponsored plan, may be entirely or partially deductible. The investments grow tax-deferred until they start to be withdrawn. Traditional IRA contributions provide an instant tax relief by lowering your taxable income in the year they are made.
Roth IRAs, on the other hand, are financed with after-tax money, so while contributions are not tax deductible, eligible withdrawals—including earnings—are, under certain circumstances, tax-free. Contributions do not lower current taxable income, but individuals who seek financial flexibility in retirement or who expect future higher tax rates may benefit from tax-free withdrawals.
Solo 401(k) and SEP-IRA
Solo 401(k) and SEP-IRA accounts are retirement savings options designed for self-employed individuals and small business owners, offering a way to save for retirement while taking advantage of tax benefits.
For instance, a Solo 401(k) allows both employer and employee contributions, which significantly raises the contribution cap and, thus, the possible tax deduction. The earnings increase tax-deferred until withdrawal, and the contributions lower taxable income, saving taxes right away. Contributions to a SEP-IRA are also tax deductible for the company, which lowers the taxable income of the company.
2. CHARITABLE CONTRIBUTIONS
Making use of the different options to donate to charities might help you save money and lower your taxes.
Donor-Advised Fund
A philanthropic account run by a public charity that enables contributors to make a charitable contribution and obtain an instant tax benefit is known as a donor-advised fund (DAF). Over time, the donor may suggest grants from the fund to the nonprofits of their choice.
Donors who contribute to a DAF can deposit cash, securities, or other assets into the fund. The donor relinquishes ownership of the assets but retains advisory privileges over how the contributions are invested and how grants are distributed to charities.
Contributions to a DAF can lower the donor's taxable income because they are tax deductible in the year of the donation. Additionally, the donor can avoid capital gains taxes that would otherwise result from selling appreciated shares or assets if the donation includes them.
Bunching Donations
A strategic tax planning technique known as "bunching donations" entails combining charity contributions from several years into a single tax year. The main advantage of bunching donations is that it enables taxpayers to take advantage of the highest possible deductions during a year with a high income or when it is most advantageous from a tax standpoint.
Donate Stock or Appreciated Assets
A donor can avoid paying capital gains taxes that would be due if they sold appreciated assets, like stocks or bonds, that they had owned for more than a year by donating them to a donor-advised fund or a qualified charitable organization.
Qualified Charitable Distributions
People 70½ and older can make direct donations to qualified charities from their Individual Retirement Accounts (IRAs) up to $100,000 through Qualified Charitable Distributions (QCDs), which eliminate the need for the payout to be included in their taxable income.
Charitable Lead Trusts and Charitable Remainder Trusts
In a Charitable Lead Trust, the remaining assets in the trust go back to the donor or other selected non-charitable beneficiaries after a certain amount of time, during which a fixed annual payment is made to one or more charitable organizations. CLTs may allow the donor to deduct income, gifts, and estate taxes, depending on the trust's structure.
The purpose of a Charitable Remainder Trust is to give non-charitable beneficiaries a stream of income for a predetermined amount of time or for the beneficiaries' lifetimes, following which the remaining assets of the trust are given to one or more charitable organizations. In addition to receiving an instant tax benefit, the donor frequently avoids paying capital gains tax on the assets they donate.
3. STATE & LOCAL TAX (SALT) DEDUCTIONS
Taxpayers can deduct specific taxes paid to state and local governments from their federal taxable income by using the State and Local Tax (SALT) deduction. State and local property taxes, income taxes, and sales taxes are a few examples of these taxes.
A ceiling on SALT deductions was established by the Tax Cuts and Jobs Act of 2017, which limits the total deductible amount to $10,000 ($5,000 for married taxpayers filing separately).
4. QUALIFIED SMALL BUSINESS STOCK (QSBS)
Shares of a corporation that satisfy specific requirements established by the Internal Revenue Code are referred to as Qualified Small Business Stock (QSBS). Subject to certain restrictions, the investor may deduct up to 100% of the capital gains from the sale of the QSBS from their income if the stock has been held for more than five years.
5. 83(b) ELECTION
Section 83(b) of the Internal Revenue Code has a provision known as the 83(b) Election, which gives workers or startup founders who receive equity compensation the option to pay taxes on the fair market value of their shares at the time of issuance rather than when they vest. If you expect your shares or the startup as a whole to appreciate significantly in value, this can offer tax advantages that could save you money when you sell your shares.
6. TAX-LOSS HARVESTING
By selling investments at a loss and utilizing the proceeds to offset realized capital gains or up to $3,000 ($1,500 if married filing separately) of ordinary income annually, tax-loss harvesting lowers taxes. Overspending can be carried over to subsequent years.
Remember to follow the wash-sale regulation. According to the rule, a tax benefit is not available if a security is sold and then a substantially identical security is purchased within 30 days of the transaction.
7. QUALIFIED OPPORTUNITY ZONE INVESTMENTS
Communities in economic distress that have been identified for investment to promote economic growth are known as Qualified Opportunity Zones (QOZs). Qualified Opportunity Funds (QOFs) are used to make investments in certain areas.
Tax advantages of these investments may include the potential exemption from taxes on the QOF investment as well as the postponement and reduction of capital gains taxes.
8. DEDUCT MORTGAGE INTEREST
Homeowners can deduct from their taxable income the eligible interest paid on a mortgage for their primary dwelling and potentially a second home under the mortgage interest tax deduction. On Form 1098, the Mortgage Interest Statement, lenders disclose how much mortgage interest the borrower paid over a specific year.
9. HSAs AND FSAs
Two kind of tax-advantaged accounts that can be used to cover qualified medical and other expenses are Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs).
Health Savings Accounts (HSAs)
People who are enrolled in high-deductible health plans (HDHPs) can apply for HSAs. Because contributions to an HSA are tax-free, investment gains grow tax-free, and eligible disbursements are tax-free, they provide what is known as a "triple tax advantage." Pre-tax money is used to deposit contributions into an HSA, which lowers your taxable income in the year of the contribution.
The maximum HSA contribution for self-only coverage in 2024 is $4,150, while the maximum for families is $8,300. The money grows tax-free and withdrawals for approved medical expenses are tax-free. It can be invested similarly to a retirement account. The fact that the money in an HSA grows tax-free over the course of your lifetime and does not count against the maximum contribution for the next year is another benefit of HSAs.
Flexible Spending Accounts (FSAs)
FSAs are employer-sponsored accounts that allow employees to set aside pre-tax dollars for eligible medical (and sometimes dependent care) expenses. Contributions to an FSA reduce your taxable income, similar to HSAs. Withdrawals used for qualified expenses are tax-free. However, FSAs generally have a “use-it-or-lose-it” rule, meaning leftover funds are lost at the end of the year.
10. BUSINESS AND SELF-EMPLOYMENT TAX EFFICIENCIES
Numerous tax deductions and efficiencies are available to small firms and independent contractors to lower their taxable revenue.
Business Expense Deductions
These could include payments to self-employment retirement plans, health insurance premiums, car expenses, and home office expenses.
Qualified Business Income Deduction
The Qualified Business Income (QBI) deduction was made available to small business owners and independent contractors by the Tax Cuts and Jobs Act (TCJA) of 2017. Up to 20% of qualified business income can be subtracted from taxable income by qualified self-employed individuals under this tax deduction.
Business Entity Restructuring
To choose the most tax-efficient business structure, small firms and independent contractors may choose to consult with a tax adviser. They often choose between an LLC, S-Corporation, or C-Corporation. By clearly defining the boundaries between business entities and individual owners, the proper business structure can reduce personal legal risk in addition to offering tax advantages.
11. QUALIFIED MEDICAL EXPENSES AND HEALTHCARE COSTS
Unreimbursed medical and dental costs that surpass 7.5% of your adjusted gross income (AGI) can be written off if you itemize your tax return. This covers a broad range of out-of-pocket costs, including prescription drugs, medical equipment, and doctor visits.
12. QUALIFIED EDUCATION EXPENSES
Through a number of tax credits and deductions, certain eligible educational costs might lower taxes. Tuition, enrollment fees, and other associated costs for a qualified student may be included in the expenses.
13. TAX RESIDENCY PLANNING
Nine US states do not levy state income taxes in 2024, while other states do not levy taxes on investment income either. For high-income individuals, startup equity holders, and cryptocurrency investors seeking to lower their tax liability, these states are the best places to lawfully claim tax residency.
14. TAX-EFFICIENT INVESTMENT STRATEGIES
High-income earners can reduce their tax liability by using a variety of investing options.
Long-Term Capital Gains
Gains or losses on an asset that is kept for a year or longer before being sold are regarded as long-term and are subject to lower tax rates than those that are held for less than a year, or what are known as short-term gains or losses. In light of this, long-term investment plans can drastically lower taxes.
Asset Location
Depending on the tax treatment of the investment income they generate, asset location entails putting investments in the most tax-efficient accounts accessible to an investor. By utilizing the various tax treatment provided by different accounts, such as Traditional and Roth IRAs and 401(k)s, the objective is to optimize after-tax returns.
Tax-Efficient Funds
Tax-efficient funds are especially appropriate for taxable investment accounts since they use a variety of techniques to lower after-tax returns. Index ETFs and municipal bond ETFs are two types of tax-efficient vehicles.
529 Plans
529 plans provide tax benefits intended to promote education savings. These plans offer tax-deferred growth and tax-free withdrawals, which means that you can take money out of them for approved educational expenditures and your assets will grow tax-free. Hawaii offers additional tax incentives for contributions made to the state’s own plan.
Anyone can start a 529 with their name as the beneficiary and then transfer it to a kid as the beneficiary, despite the prevalent belief that 529s must be opened for a child. This enables you to make 529 investments for a longer duration.
Municipal Bonds
The primary advantage of investing in municipal bonds is that interest income is typically free from federal income taxes. Interest income from municipal bonds issued in the investor's home state is frequently excluded from state and local taxes in addition to the federal tax exemption.
15. ROTH CONVERSIONS
People who earn more than the IRS limits can nonetheless contribute to a Roth IRA by using a backdoor Roth IRA conversion. Contributions are made to a Traditional IRA and then converted to a Roth IRA. A Traditional IRA conversion is a taxable event, and income taxes are due on any pre-tax contributions and converted investment earnings; however, once funds are in a Roth IRA, they can grow and be withdrawn tax-free in retirement.
High-income individuals who have a 401(k) plan at work may also want to think about a big backdoor Roth conversion, which entails making post-tax contributions to the 401(k) and then rolling them over into a Roth 401(k) or Roth IRA. Keep in mind that post-tax dollar contributions are not permitted in all 401(k) plans.
16. REAL ESTATE INVESTING
You can use real estate in a variety of ways to reduce your tax liability.
Rental Property Depreciation
The IRS permits a tax deduction for a portion of the annual cost of rental property if it is utilized for business purposes or for another activity that generates money.
1031 Exchange
You can postpone capital gains taxes by selling an investment property and using the profits to buy a new one through a Section 1031 Exchange, sometimes referred to as a Like-Kind Exchange. Essentially, it enables you to exchange one investment property for another, postponing your tax obligation until later.
17. DEFERRED INCOME
Different strategies to postpone job income may place you in a lower tax bracket for a certain year, depending on your circumstances.
Timing When You Exercise Stock Options
Complex tax obligations may arise from exercising stock options, including incentive stock options (ISOs) and non-qualified stock options (NSOs). The tax burden when exercising stock options is mostly based on your income tax level and the fair market value of your shares, and both ISOs and NSOs have varying tax treatment.
Working with a tax expert is beneficial in order to comprehend the tax implications of exercise stock options because ISOs and NSOs are situational.
Negotiate Deferred Compensation
You can think about negotiating a deferred compensation plan, which would enable you to receive payments over a longer period of time, when assessing a job offer and depending on your compensation package.
Deferred compensation can help ultra-high income earners lessen their tax bill by perhaps keeping them in a lower tax bracket because income is not taxed until it is received.
Negotiating the timing of year-end bonus payments and other incentive money is something else you might want to think about. A sizable bonus could put you in a higher tax band and increase your tax liability, depending on your circumstances.
18. TAX-EFFICIENT NON-CHARITABLE GIVING
Taxpayers are permitted by the IRS to give a certain amount annually to as many people as they like without disclosing it on a gift tax return. Known as the yearly gift exclusion, the IRS defines what constitutes a gift, and the maximum amount changes annually.
The yearly gift tax threshold for individuals in 2024 is $18,000, while the threshold for married couples is $36,000.
19. ENVIRONMENTAL TAX BREAKS
The IRS offers tax credits for a portion of qualifying costs incurred when you make energy upgrades to your house. Solar, wind, and geothermal power generation, as well as upgrades to external doors, windows, skylights, insulation, and other components, are examples of qualified improvements.
Environmental tax credits may also be available for second properties used as residents.
20. TAX-EFFICIENT ESTATE PLANNING
By eliminating assets from your estate, some estate planning strategies, like creating an irrevocable trust or parent-seeded trust—officially known as a Beneficiary Defective Inheritance Trust (BDIT)—may lower your tax obligations.
Consult a tax professional for more information. Because estate taxes are intricate and necessitate a thorough comprehension of the tax system, a tax advisor or lawyer can be a useful collaborator in developing tax-saving plans.
Tax Deduction FAQs for High-Income Earners
What are Tax Deductions?
Expenses that taxpayers can deduct from their gross income to calculate their taxable income and lower their overall tax burden are known as tax deductions or tax write-offs.
What is Form 1098?
In the US, lenders give borrowers who have paid mortgage interest during the year a tax form called Form 1098, sometimes referred to as the Mortgage Interest Statement. Three other types exist as well: Form 1098-C for gifts of automobiles, boats, and aircraft; Form 1098-E for interest on student loans; and Form 1098-T for tuition.
Should I Take the Standard Tax Deduction or Itemize Deductions?
Your unique financial circumstances will determine whether you choose to itemize deductions on your tax return or take the standard deduction. You should consider both options when paying taxes and choose the one that lowers your total tax obligation. During the tax filing process, a qualified tax expert can help you with deductions.
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