Yay! I love preparing taxes!
Wait, we’ve never heard anyone say that before. Except perhaps a CPA who really loves their job.
Why should you care about your taxes when it’s not even the tax season yet? For high earners, this is one area of your finances where you could significantly lose or save money if you have the right knowledge. The more money you earn, the more important your tax planning strategies become.
Tax law is complex, and constantly changing. Unless you’re that CPA we mentioned, you might have trouble figuring out exactly what applies to you and what strategies you could take advantage of to your benefit. A financial professional who has your best interests in mind could help you with tax planning – a financial strategy that starts long before the month of April.
California Wealth Transitions is not a CPA Firm; always consult with your CPA professional regarding the strategies discussed below.
These are situations that can make reducing your taxes a priority when it comes to managing your finances:
Do you have a higher-than-average salary?
Do you own a profitable business or are you self-employed?
Do you own real estate or have real estate you have inherited?
Do you have capital gains?
Pay attention if you want to reduce your income taxes.
Strategies for Reducing Income Taxes
Utilize the Right Retirement Accounts
How you save for retirement can significantly impact your income tax levels. Obviously you want to fully fund any retirement accounts offered by your employer, but if you are self-employed, set up the proper accounts. Anyone can set up a traditional IRA, deductible or non-deductible and you may also be eligible for a ROTH IRA depending on your level of income. If you’re self-employed, consider setting up your own SEP IRA or Solo 401k and contribute as your own employer. This is fully deductible as a business expense. Which one is right for you depends on your Modified Adjusted Growth Income (MAGI) and whether or not you have employees.
Many high income earners already have their basic retirement accounts covered. The question is what accounts to prioritize with your additional saving strategies to make every dollar as tax efficient as possible. Anticipate medical expenses and potentially long-term care expenses by utilizing a Health Savings Account (HSA). A financial professional can analyze pre-tax, backdoor strategies, and after-tax contributions to help you determine where to put your additional funds.
Know What You Own and What You Owe
This sounds like a basic idea, but high earning individuals tend to have many different streams of income and assets in many different forms from insurance policies to real estate. Do you have a statement of net worth that lists all your assets and their value? Is it up-to-date? This is really where tax planning starts. This can also impact your future estate, too – so it’s important!
Use Charitable Donations
Are you inclined to contribute to your favorite charities and gain the tax benefits? You can deduct up to 60 percent of your adjusted gross income each year for these gifts. And guess what…don’t think of charitable donations as cash only. You can donate stock and this could be an advantageous strategy for you especially if you have stocks that have increased in value since you purchased them.
Know What You’re Entitled to as a Business Owner or Real Estate Investor
Ever heard of the 199A deduction? This is a significant deduction that can make a big difference in what you owe. You can deduct up to 20% of the profits of your small business or your rental real estate, allowing sole proprietors, partnerships, and S corporations to reduce taxable income. These are tax deductions, not tax credits and there are certain limitations so check with your tax professional.
Consider Donor-Advised Funds (DAF)
Consider establishing a donor-advised fund, or DAF, which is essentially a personal charitable savings account. A donor can create a fund with contributions in many forms including cash, stock, or other assets and receive an immediate tax deduction for the gift.
To Defer, or Not to Defer … That Is the Question
Many high earners wonder if it’s better to pay taxes now or later. The truth is, if you’re in a top-tier tax bracket now, you most likely will be during your retirement. Deferring taxes now might be taxed at a higher rate in the future. However there are many caveats and nuances to tax deferral. Many high income individuals can benefit from tax-deferred annuity options and life insurance policies as savings vehicles. It really just depends on your individual situation. There is no “one-size-fits-all” answer to this question but it is worth discussing with your financial team.
Protect Your Estate
Do you want to keep as much of your wealth in the family as possible? Of course you do. Consider a Grantor Retained Annuity Trust (GRAT), which can allow you to pass your wealth to the next generation without a significant tax impact. We’ll cover more on protecting your estate to transfer your wealth in our upcoming blog.
Tax planning encompasses a lot of fine tuned strategies that can hold big impact. Our final thoughts on taxes for high earners?
Don’t make panicked decisions at the end of the year in an effort to reduce your taxable income. This is rarely a good move. Consult a professional and start early – get your tax strategy together before the end of the year!
Remember that the IRS isn’t likely to tell you that you’ve overpaid. Perhaps you have your taxes pretty well in line. But have you explored ALL of the options? Trust a professional who has resources at their disposal to get all the pieces of your financial life working together.