10 Tax Strategies for High Income Earners: Avoid the Tax Man - Physician on FIRE (2024)

While Tax Day for US readers in 2023 may have just been a couple of days ago, it’s always useful to think of ways to optimize your taxes.

After all, you want to ideally pay what you owe Uncle Sam without leaving him a tip.

Luckily, as a high-income professional, there are many strategies available to you to reduce taxes legally while also investing in your future.

And looking at the tax code can help us figure out how the IRS would like us to receive our income–and help guide our investing to fit that “template.”

This post, from Debt-Free Doctor, takes us into this.

If you make a lot of money, then there’s a good chance that you’re paying too much to the tax man. High-income earners understand that their biggest expense during their lifetime is taxes.

No one wants to pay more in taxes than they have to, which is why the ultra-wealthy understand how to play the tax game. If you want to take advantage of their tax reduction strategies, then you’ll need to either stay on top of the ever-changing tax laws or surround yourself with advisors that can do it for you.

In this article, I’m going to highlight 10 tax strategies that you can use to avoid paying the IRS any more than you should.

Disclaimer: I’m a periodontist and NOT a tax advisor or financial planner. Please seek the advice of your own personal one to assist with your financial situation.

Let’s get going…

Tax Basics

Do you know what tax rate you’re in? Before we get into the particular strategies for lowering your tax burden, it’s necessary to understand how taxes work. Understanding tax brackets is important because they determine the amount of tax you owe the IRS based on your taxable income.

It’s vital to understand that taxable income is not the same as adjusted gross income (AGI), which is your total gross income minus the IRS-allowed above-the-line deductions.

To figure out taxable income, you take the AGI and subtract personal exemptions and itemized deductions, which are also called below-the-line deductions.

High-income earners should always know how the next dollar of earned income will be taxed.

Capital Gains Tax

It’s also important to understand how the capital gains tax works.

A capital gain occurs when you sell an asset for morethan you paid for it.

Here’s the formula:Capital Gain=SellingPrice−PurchasePrice

To the federal income tax rates above, you may also have to add capital gains taxes, as shown here in the long-term capital gains chart:

If you live in a state with high taxes, like California, you may have to pay state income tax and capital gains tax on top of federal taxes. If you include the extra Medicare surtax, these can add up to a rate of around 54.1% for high-income earners. Ouch!

Applying just one technique rarely results in tax burden reduction. The fact is that implementing tax strategies for high earners requires a combination of techniques. Some of these methods may result in a tax being applied right away. Others may lower your lifetime tax burden by lowering your taxable income.

Make sure you discuss potential ways to lower your tax burden with your personal CPA or financial advisor.

10 Tax Strategies For High-Income Earners

Here are the latest ways to reduce taxable income:

#1. Max out retirement accounts

A retirement account, like a 401(k) or 403(b), can help you pay less tax on your income. When you contribute to these accounts through your job, it’s not taxed until you take it out. Every year you contribute, your tax bill is reduced.

After you retire, it’s likely that you’ll be in a lower tax bracket, so the money you take out will be taxed at a lower rate than if you had paid taxes on it when you earned it.

Contributing the maximum amount to your retirement plan will help you save the most on taxes, and the lifetime tax savings are likely higher than the amount you contribute.

Here’s a list of some of the contribution limits in 2023:

• 401(k): The annual contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is $22,500 for 2023. The catch-up contribution limit for employees age 50 or older in these plans is $7,500 for 2023.
• SEP IRAs and Solo 401(k)s: The contributions an employer can make to an employee’s SEP-IRA cannot exceed the lesser of25% of the employee’s compensation, or$66,000 for 2023.
• SIMPLE IRA: The contribution limit for SIMPLE retirement accounts is $15,500 for 2023. The SIMPLE catch-up limit is still $3,500.
• Defined Benefit Plans:The limitation on the annual benefit of a defined benefit plan is $265,000 for 2023. These are powerful pension plans for high-earning self-employed individuals.
• Individual Retirement Accounts (IRA): The limit on annual contributions to an Individual Retirement Account (pre-tax or Roth or a combination) is $6,500 for 2023. The catch-up contribution limit, which is not subject to inflation adjustments, remains at $1,000.

#2. Health Savings Account

A Health Savings Account (HSA) is like a 401(k) in that it helps you save money on taxes and lets your money grow without being taxed. But an HSA has the added benefit that you don’t have to pay taxes when you take money out to pay for health care.

Also, there is no penalty for taking money out of an HSA after age 65, which could make it a better choice than a 401(k) in some cases.

HSAs are available only if you’re enrolled in a high-deductible health plan (HDHP).

HSAcontribution limits for 2023 are:

• • $3,850 for individuals
  • $7,750 for families
  • $1,000 55+ catch-up contributions

#3. Maximize itemized deductions

To get the most out of itemized deductions and reduce your tax bill, you’ll need to add up all of your eligible expenses and compare them to the amount of the standard deduction.

The standard deduction is a set amount that lowers the amount of your income that you have to pay taxes on.

For 2023, the standard deduction is:

• • • $13,850 single
    • $27,700 married filing jointly

If you itemize your deductions and they’re greater than the standard deduction, you may be able to lower your taxable income.

Research shows that around 90% of taxpayers do not itemize deductions and take the standard deduction instead.

Tax deductions and credits may be available to both business owners and W-2 employees. Some of these deductions and credits have income limits and may phase out as income grows, while others do not.

Individuals may deduct the following as itemized deductions:

• • • state and local taxes
    • real estate taxes
    • personal property taxes
    • mortgage interest
    • charitable contributions
    • medical and dental expenses

It’s important to maintain records and paperwork for any costs you intend to claim as itemized deductions.

#4. Contribute to a Roth account

A Roth IRA and other Roth retirement accounts, such as Roth 401(k)s, Roth 403(b)s, and Roth 457(b)s, can be beneficial tax planning tools.

Contributions to these accounts do not provide an immediate tax benefit, but any money earned in the account is tax-free when removed in retirement. This means that, while contributing to a Roth account may not reduce your tax burden in the current year, it may save you money on taxes when the earnings are withdrawn during retirement.

#5. Tax loss harvest

Tax loss harvesting is a method that involves selling investments that have lost their value in order to offset capital gains and lower your tax bill.

This is how it works: Assume you have two investments in your portfolio, one that has increased in value and one that has decreased in value. If you sell an investment that has increased in value, you’ll have a capital gain and will be taxed on it.

However, if you sell a depreciated investment, you will face a capital loss. This capital loss can be used to offset any capital gains and decrease your overall tax liability.

For example, if you have a $1,000 capital gain and a $500 capital loss, you will only owe taxes on the $500 net capital gain ($1,000 gain – $500 loss).

#6. Qualified opportunity zone investments

If you sold an asset and made a large profit, you may be able to put off paying taxes on that gain and have a portion of it forgiven if you invest in a qualified opportunity zone (QOZ).

An Opportunity Zone is aneconomically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Congress created this program as part of the Tax Cuts and Jobs Act of 2017to encourage long-term investments in low-income urban and rural communities nationwide.

One of the major tax benefits of investing in a Qualified Opportunity Fund investment is thedeferral ofcapital gains taxes. This benefit allows a temporary tax deferral on any capital gains by investing those gains in a qualified Opportunity Zone fundwithin a 180-day periodof realizing the gain.

If you have realized a capital gain from the sale of an asset or an investment, you can invest those gains in a qualified Opportunity Zone Fund anddefer paying taxes until 2026.

In addition, if you hold your investment in the fund for at leastfive years, you’ll receive a10% reduction andfor at least seven years, you’ll receive a15% reduction. If you keep the investment for at least 10 years, it won’t have any capital gains when you sell it. This means you’ll have to pay less in taxes on the original capital gain.

#7. Real estate depreciation

Depreciation is a tax break that allows real estate investors to deduct the cost of their rental property over time. The Tax Cuts and Jobs Act reinstated bonus depreciation, which allows investors to deduct a specific percentage of the cost of their property in the year it was purchased.

This benefit will be phased out from 2023 to 2026, after which investors will be able to depreciate their homes at a slower rate.

Real estate investors can take advantage of bonus depreciation by having a cost segregation study performedon their properties to determine which aspects of the building are “dedicated, decorative, or detachable.” These items may be eligible for 100% bonus depreciation in the year of purchase.

This benefit is estimated to be worth 20% to 25% of the building’s purchase price.

See the video below for a more in-depth look at how bonus depreciation works along with its phase-out schedule:

Also, high-income earners who spend at least 750 hours in their real estate business and do not dedicate additional time to another profession may be eligible for “real estate professional” status.

This allows them to offset earned income with passive losses from depreciation. It’s not required to hold a real estate license to earn this status, and married couples may choose to have one spouse obtain real estate professional status while the other works in a high-paying position.

#8. Hire kids if you’re a business owner

People who own their own businesses can lower their taxes by hiring their own children. You can put your kids on the payroll if they’re old enough to legally work for your business.

As long as your children are under 18, you don’t have to pay Social Security and Medicare taxes on their earnings. Their earnings will be taxed at their own tax rate, which is usually lower than an adult’s tax rate.

To use this tax strategy, you must pay your children a fair-market-value salary which is the same amount you’d pay a different worker to do the same job.

#9. Set up a donor-advised fund

A donor-advised fund (DAF) is a charitable fund that you can set up that allows you to decide how and when to allocate funds to charities.

A donor-advised fund is a type of charitable fund that lets you give money and receive a tax break in the same year. You can then decide how and when to give the money to different charities. This means that you can get the tax benefits of giving to charity on your current tax return, but you can choose which charities to help and how much to give at a later date.

With a donor-advised fund, you get the tax deduction when you give money to the fund, not when the money is given to charities. This can help you plan your taxes and give money to good causes.

#10. Own or start a business

As a business owner, you have to pay taxes on your business’s profits, not on its total income. This means that as a business owner, you may be able to get more tax breaks than you would as a W-2 employee.

It’s important to remember that tax deductions don’t make your business more money. Instead, they just lower the amount of profits that have to be taxed.

For example, if you have a $1,000 expense and can fully depreciate it right away, you might be able to save around $300 in taxes (assuming your combined federal and state marginal tax rate is 30%). But your business’s profits for the year would go down by $700 because of this.

Even though tax deductions can help you pay less in taxes, it’s important to remember that they don’t make you more money. If you have expenses coming up, you might be able to get the tax benefit of those expenses a year earlier if you pay for them in December instead of January.

Reduce Taxes With Smart Tax Planning

Working with a CPA who understands the tax code and can help you identify which incentives and tactics may be most beneficial for you is recommended to locate the best tax reduction methods for your situation.

If you want to work with the group I highly recommend, then schedule a Free Strategy Session – For Asset Protection and Tax Planning with Anderson Advisors.