TAX REDUCTION STRATEGIES FOR HIGH-INCOME EARNERS
You’ll be relieved to learn that there are numerous tax-reduction techniques available for high-income workers if you’re in a high tax bracket. To pursue them, though, you must be tenacious enough, or you must seek the assistance of an excellent tax strategist.
High-income earners and wealthy individuals may find it challenging to keep up with the most recent tax planning techniques due to the regular changes in tax regulations and growing complexity.
Your taxes will get more challenging the more money you earn. Therefore, it’s crucial to engage with a knowledgeable accountant to determine ways to lower your income taxes if you earn more than the average person. There are several things you may do to reduce the amount you pay, in addition to taking your standard deduction and additional deductions.
Keeping up with the most recent tax regulations can be difficult, even with a free cheat sheet as a reference.
For instance, since 2017 there have been two significant revisions to tax law!
The biggest revision to the tax law in a generation was made by the Tax Cuts and Jobs Act of 2017. For several individual tax brackets, the income tax rates were slightly reduced by new tax legislation.
However, the tax adjustments, which increased the standard deduction for both single and joint filers, are only temporary. For those with high incomes, it will be more difficult to find sufficient deductions to itemize moving forward in 2022 due to a greater standard deduction of $12,950 for individuals and $25,900 for joint filers. Additional tax measures, such as the 2019 Taxpayer Certainty and Disaster Tax Relief Act and the new SECURE Act, were passed in December.
Both tax reforms made significant changes to the tax system. Then, how can you benefit from these new tax regulations, and what tax-saving options are still available to high-income earners?
Tax Fundamentals and New Tax Laws
It’s crucial that you comprehend the fundamentals of taxes, starting with tax brackets, before we go on to tax reduction tactics.
Not to be confused with adjusted gross income, your federal tax bracket is the percentage of tax that you owe the IRS on each tier of your taxable income. A person’s adjusted gross income (AGI) is typically equal to their total gross income less any above-the-line deductions that the IRS permits.
A person’s taxable income, on the other hand, is their adjusted gross income less any personal exemptions and itemized deductions (sometimes referred to as below the line deductions).
You can use the table below to establish your federal tax bracket once you know your taxable income. High earners should always be aware of the tax rate that will apply to their next dollar of income.
Depending on your taxable income, federal tax rates start to fall into the following categories in 2022.
2022 FEDERAL TAX BRACKETS
|TAX RATE||TAXABLE INCOME (Single)||TAXABLE INCOME (Married Filing Jointly)|
|10%||$0 – $10,275||$0 – $20,550|
|12%||$10,275 – $41,775||$20,550 – $83,550|
|22%||$41,775 – $89,075||$83,550 – $178,150|
|24%||$89,075 – $170,050||$178,150 – $340,100|
|32%||$170,050 – $215,950||$340,100 – $431,900|
|35%||$215,950 – $539,000||$431,900 – $647,850|
|37%||Over $539,000||Over $647,850|
Tax rates on dividends and capital gains: For 2022, the tax rates themselves don’t change, but the income thresholds did.
|FILING STATUS||0% RATE||15% RATE||20% RATE|
|MFJ||<$83,350||$83,350 – $517,200||>$517,200|
|Single||<41,675||$41,675 – $459,750||>$459,750|
|Estates / Trusts||<$2,800||$2,800 – $13,750||>$13,750|
The SECURE Act
The SECURE Act, which was included in the tax package passed in December 2019, has a number of features that have an impact on your tax and retirement planning methods. The SECURE ACT makes a number of significant modifications that have an impact on high-income earners’ tax minimization tactics.
Important figures for 2022 include the following:
The required minimum distributions (RMDs) age was increased from 70-12 to 72 in 2020; nevertheless, if you hit 70-12 in 2019, you still had to begin taking RMDs in 2020.
The age restriction for Traditional IRA donations has been removed.
The 2022 annual contribution limits for 401(k)/403(b) plans are now $20,500 and $14,000, respectively; the limits for traditional and Roth IRAs remain at $6,000 each. For 401(k)/403(b) plans, catch-up contributions are still $6,500; for SIMPLE IRAs, they are still $3,000; and for Traditional and Roth IRAs, they are still $1,000.
The Roth IRA income cap increased. For single individuals earning between $129,000 and $144,000 and for married couples filing jointly earning between $204,000 and $214,000, contributions phase out. The range of $204,000 to $214,000 now serves as the phaseout range for traditional IRA contributions made on behalf of an uninsured spouse.
In 2022, the Social Security wage base will rise to $147,000. The total amount of income that is subject to social security taxes is this. This implies that you will once again contribute more to social security.
Deductions for long-term care premiums are now limited to $4,520 for people ages 60 to 69 and $5,640 for those who are 70 or older. This means that in 2022, a married couple’s long-term care insurance premiums can be written off up to $11,280. Self-employed individuals can deduct all of their premiums in full on Schedule 1 of the 1040.
Last but not least, a tax deduction is a deduction that lowers a taxpayer’s tax obligation by lowering his adjusted gross income and possibly his taxable income. Your chances of reducing your tax liability increase with the number of deductions you may locate.
Above-the-line deductions and below-the-line deductions are two significant subcategories of tax deductions. The reference to the “line” is your adjusted gross income (AGI).
Let’s discuss above-the-line and below-the-line deductions now that you have a basic understanding of tax brackets, the new Secure Act, and tax deductions.
Above the Line Deductions for 2022
Whether you itemize or take the standard deduction, above the line deductions are permitted and lower your adjusted gross income. Above-the-line deductions are crucial since they may increase your eligibility for additional deductions or credits on your tax return by lowering your AGI. The following above-the-line deductions may be taken into account by high-income earners:
Donations to health savings accounts. HSAs offer three different tax advantages: Contributions are tax deductible, earnings are tax-free as they grow, and withdrawals are tax-free for eligible medical costs for those under the age of 65 and for any purpose for those 65 and above. Individual and family contribution caps for 2022 are $3,650 and $7,300, respectively. If you are 55 years of age or older, you may add an additional $1,000.
Traditional IRA contributions that are deductible. Depending on whether you have access to a group retirement plan or not, there are differing income thresholds for contributions to Traditional IRAs that are tax deductible. There is no income cap for receiving the deduction if you and your spouse are not eligible for a group plan. For a married couple with only one spouse having access to a group retirement plan, the MAGI limit to deduct contributions ranges from $204,000 to $214,000. The MAGI range for the deduction is $109,000 to $129,000 if both spouses have access to a group plan. The MAGI cap for a single filer with access to a group retirement plan is between $68,000 and $78,000.
Contributions to qualified retirement plans. To entice suitable candidates, many firms provide qualified retirement savings plans like 401(K), 403(b), and 457 plans. One of the simplest methods for individuals with high incomes to lower their taxes is if their company provides one of these programs. Your paycheck is immediately affected by reductions; your tax return is not even affected. Net of any pre-tax retirement plan contributions is the income reported on IRS form 1040.
Suitable donations to charities. A qualified charitable distribution (QCD) is a payment made directly to a qualifying charity from an individual’s IRA who is age 70 12 or older. Simply put, the IRS permits you to make tax-free IRA payments to institutions like your church or favorite charity. If you have a charitable streak, a QCD may be able to save you thousands of dollars in taxes.
Below the Line Deductions
After determining your AGI, below-the-line deductions—also referred to as standard deductions or itemized deductions—are determined. Sadly, not all below-the-line deductions will result in a reduction in your taxable income. Estimates indicate that approximately 90% of filers will ultimately choose the standard deduction over itemized deductions. The standard deduction in 2022 is $12,950 for single people, $25,900 for married couples filing jointly, and higher for blind people and people over 65.
For high income individuals, itemizing deductions is substantially more difficult than in previous years. There is a good chance that itemizing your deductions will further lower your tax if you prepare ahead. Several tactics for lowering taxes include:
Contributions to charities. You can minimize your income tax and increase your charitable giving by utilizing a variety of tactics. To maximize tax benefits, high-income individuals might think about donating low cost basis shares, making a donation to a donor advised fund, or bundling future charitable contributions into one year.
Charges for mortgage interest. If you currently rent an apartment or have a sizable balance on your credit cards, you might think about buying a property or refinancing with cash out to benefit from the tax deduction for mortgage interest. Tax deductions on funded principal of up to $750,000 may be available in 2022.
Medical costs. Keep an accounting of your medical costs. Even though you might be in good health, you might be able to deduct some of your medical costs if you have a larger family or a special medical need. In 2022, you may deduct medical costs that are more than 7.5 percent of your AGI as an itemized deduction.
Income Deferral or Acceleration
Although it may not always be the best course of action, deferring or accelerating taxable pay may lessen your exposure to income and capital gains taxes as well as the 3.8 percent Medicare surtax on investment income.
Deferring revenue is more than just doing so for the current year. Tax-savvy folks are aware that developing a long-term income deferral strategy can aid in hastening the compounding of your investments and savings.
The current tax rates are temporary and are set to expire in 2025, so you should keep this in mind when you think about tax reduction techniques for high-income earners. As a result, money you postpone in 2022 might actually be taxed at a higher rate later on.
Income Strategies to Consider:
Take contributions to non-qualified deferred compensation into account. You can lower your taxable income this year and increase your post-retirement savings if your employer offers a deferred compensation plan.
Ask your employer to defer your income until 2023. Are your commission earnings strong this year? If so, your taxable income this year may be more than it is the next year. Consider asking your company to delay paying your income until 2023 if you anticipate earning commissions or other forms of earned income late in 2022. Delaying income until the following year may help you pay less in taxes by moving it into a lower tax band if your taxable income is expected to be lower.
Retirement IRA withdrawals should be postponed or accelerated. You might profit from accelerating or deferring IRA distributions until a later date, depending on your tax bracket. For instance, if you anticipate being in a higher tax band in the future, changing traditional IRA savings to a Roth IRA may be advantageous. On the other hand, if you need to lower your taxable income for current year, you can think about deferring IRA withdrawals. Either approach may eventually help level up your tax brackets, lowering the amount of income tax you pay in retirement.
Income Tax Deferral
Investment vehicles that allow for tax-deferral are not the same as those that are tax-exempt (like Roth IRAs or HSAs); when the assets are distributed, there will eventually be tax repercussions. Tax-deferred accounts, however, can be a useful tax technique for high-earners to lower current year tax obligations. Tax-deferred accounts also benefit from quicker compounding returns since they shield income from current taxation.
Tax-Deferred Investment Vehicles
Qualified retirement plans. One of the simplest methods to delay investment income is to make a contribution to a 401(k), 403(b), or 457 plan. As previously mentioned, the SECURE Act enables high-earners age 50 and older to contribute $27,000 year to a 401(k), giving you more discretion over when you retire. You won’t pay tax on dividends, interest, or capital gains until you actually take a payout from the account at age 59 12 or later, which means that your profits are protected from taxation until withdrawal.
529 plans for education. Contributions are subject to federal taxes, but the funds grow tax-free and withdrawals for eligible educational costs are not subject to taxes. There are no annual contribution caps, but beginning in 2022, contributions that exceed $16,000 for each donor and beneficiary will be deducted from the lifetime exemption for estate and gift taxes. For Virginia residents interested in learning how to lower their state income taxes, up to $4,000 per account each year is deductible. These accounts can now be used to pay up to $10,000 a year in private school tuition.
Consider life insurance with cash value. Due to the greater investment restrictions, this is one of the most widely used tax deferral schemes for high-income taxpayers. Withdrawals up to the amount of premiums paid are tax-free, but contributions made with after-tax money can grow tax-free.
Modify the Nature of Your Income
Your portfolio’s assets can be changed to alter how your income is taxed. If you run a business, you may be able to reduce your taxes significantly by altering the way your company is structured.
Here are a few possibilities:
Make a Roth conversion with your regular, SEP, or SIMPLE IRA. Roth distributions are typically tax-free beyond age 59 12 (assuming you’ve complied with the five-year criteria). Additionally, because they aren’t regarded as investment income, they won’t raise your MAGI enough to be subject to the 3.8 percent Medicare surtax. Roth conversions can be a potent tool to lower the taxation of your future income, but you’ll need to look at your federal tax brackets.
Invest in tax-exempt bonds. Federal income tax and the Medicare surtax are not applied to interest income from tax-exempt bonds. Even better, interest on municipal bonds acquired in your place of residence is exempt from federal and state income taxes.
Reorganize the structure of your company. By incorporating your company, you can select the tax arrangement that best suits your financial situation. For instance, the top tax rate for a C-corp is lower than that of an S-corp or a sole proprietorship. A new deduction of up to 20% of company income may also be available for earnings from a pass-through corporation. You can hire your young children without having to deduct or match payroll taxes if you convert to a sole proprietorship. Earnings of children are also taxed at a reduced rate.
Invest your money to a health savings account. Many people with high incomes either don’t use HSAs at all or use them improperly. If you are eligible for a Health Savings Account, think about investing your contributions rather than using them for immediate medical costs. If used for a legitimate medical expense, earnings will increase tax-free and future distributions will also be tax-free.
Invest in exchange-traded funds and tax-efficient index mutual funds (ETFs). Every high earner should have a strategy in place to diversify how their retirement income will be taxed. A tax-efficient index mutual fund and/or ETF for taxable accounts may assist in lowering the yearly taxes you pay on your assets. Actively managed funds can sometimes be more tax-efficient than index funds and ETFs.
Schedule Your Gains or Losses
Managing the timing of substantial gains to avoid being subject to the Medicare surtax or being pushed into the 20 percent capital gains bracket should be a part of effective tax strategy for high-income earners.
Here are some methods for controlling your gains:
Create a charitable remainder trust and contribute valued securities to it. In charitable remainder trusts, income is distributed to beneficiaries for a predetermined amount of time before the balance is given to a charitable organization. You can avoid paying gains tax and receive a deduction based on the current worth of the gift by giving a long-term, valued asset.
Invest in a QOF, or qualified opportunity fund. By investing capital gains in a QOF within 180 days after the sale, you can delay paying taxes on those gains until 2026 because to this provision of the Tax Cuts and Jobs Act. By keeping the investment for at least five years, taxes can be decreased.
Reap the benefits of your assets’ unrealized losses. You might think about selling investments in taxable accounts that have losses when the stock market declines. You can sell your investments using a technique called “tax-loss harvesting” to record your losses. The IRS will allow taxpayers to deduct up to $3,000 in losses from regular income in 2022 and to offset those losses with capital gains from current and subsequent tax years. Losses that are not used in the current year may be carried over to the following ones.
Put Your 529 Plan Contributions Together
There is a unique provision for 529 plans if you wish to optimize your family donation. As a first contribution to a student’s 529 plan, an individual is permitted to make up to $75,000, or five years’ worth of gift-tax exemptions, in a single year.
It’s important to note that your lifetime exclusion will be lowered if you give the same student any more gifts over the following five years. But the student benefits from a jumpstart on his account, and the money has more time to compound and increase.