Earning a good living and amassing a large net worth are both aspects of the American dream. Paying a lot of taxes is not. As a US taxpayer, it is critical to strike a balance between paying your fair share and making wise decisions that will allow you to continue to grow your wealth. If you are a high-income earner, implementing tax reduction strategies is the best move to make. Here are a couple of tax planning strategies that will be highly effective for you.
1. Taking advantage of all of your allowable tax deductions and credits
Tax deductions are expenses that can be deducted from your taxable income (and therefore your tax liability). There are also a lot of tax credits available, which reduce your tax liability dollar for dollar. There are more deductions and credits available against business income, but there also is a good amount of options if you are just a W-2 employee. There are deductions and credits that phase out and disappear as income increases, but some are not subject to income limitations. It is important to discuss this with your tax advisor, as most tax advisors provide a questionnaire for tax preparation, and completing the questionnaire helps the tax advisor determine which deductions and credits are available for the taxpayer to take advantage of.
2. Income splitting and trusts
This is one of the most important tax strategies for you, as a high-income earner.
If properly structured, family trusts or partnerships can help you move your investment earnings to family members with lower marginal tax rates. This has to generally be done within annual gift exclusions, or loans. If children are involved, we have to be mindful of the kiddie tax limitations.
Trusts can also help reduce your state income tax liability on investment earnings, so while the Federal tax rate stays the same, there are savings on state taxes. This is an important strategy for residents of high-income tax states, with significant investment income.
3. Business owners hire your kids
Another tax planning strategy for individuals that have their own business is to hire their children. If you have children who are of legal working age and have free time to do administrative work for your company, add them to the payroll. A business owner is not required to pay Social Security and Medicare taxes on their children’s earnings as long as the children are under 18 years old, and their earnings are taxed at their tax rate. This way, the owner is shifting the tax burden to their children, who have lower tax rates. However, if you are using this strategy, please remember to pay your children a fair market value salary.
4. Benefit from non-taxable income
There are a few types of income that are not subject to taxation, so if you have those types of income, it is tax-free. For example, income in a Roth IRA, income in a life insurance contract, income from renting your home for less than 14 days, income from being an original owner of a corporation for more than 5 years (up to $10,000,000 of the gain on sale can be excluded), and etc.
5. Use Real Estate exemption or rollover
In real estate, there are a few main ways to reduce or defer taxes depending on the property usage. If it is your primary residence, and you sell it after you used it as such for more than two years, you can exclude up to $250,000 ($500,000 if married filing jointly) from the gain. If it is a rental property, you can consider doing a 1031 exchange, where the proceeds of the sale of the first property are invested into a new property, creating a tax deferral on the gain.
6. Invest in opportunity zones
Opportunity zones were created with the Tax Cut and Jobs Act of 2017, and they allow a taxpayer to invest capital gain earnings into special opportunity zones, creating a tax deferral on the capital gain until the new investment in the opportunity zone is sold, or December 31, 2025, whichever is earlier. Additionally, if any income is earned on top of the original investment in the opportunity zone, such income is not taxable.
7. Make Donations for Charity
Philanthropy is a goal for many high-income earners, not only because of its positive public image but also because of the tax benefits. There is no tax on any capital gain if you donate cash or securities to a charity. Receiving a receipt allows you to deduct your return and reduce your taxable revenue.
It is recommended that you donate valuable assets such as real estate, bonds, or stocks for the long term. You will not be taxed on their profits and can claim a tax deduction of generally up to 30% of your adjusted gross income.
8. Invest in companies that pay dividends
You’re not alone if you’ve ever questioned why billionaires pay lower taxes. The answer could be found in dividends. The majority of billionaires’ wealth is derived through shares in a company that generates money for its shareholders. Long-term capital gains, like these, are taxed at a significantly lower rate than earned income.
9. Select Investments that are Tax-efficient
To generate and maintain more profits, you can invest in tax-efficient securities and assets. Investing in resource-based companies, such as oil, gas, renewable energy, mining companies, and others; comes with many tax benefits. These businesses can “renew” the costs they incur on you, which you can then deduct on your tax return up to the amount of the investment you made with the proper structure. This reduces your overall net revenue.
10. Make a contribution to your pension fund
To begin, you can reduce taxable earnings by maximizing your pension contributions, and thus reducing your income taxes. Business owners and self-employed individuals can generally defer larger amounts for retirement. The maximum amount also depends on the type of retirement plan in place. For W-2 employees, it is important to contribute as much as they can to the plan at their respective workplace. For business owners and self-employed individuals, it is also important to choose the right type of retirement plan, which would allow the maximum contribution for the taxpayer.
While this is not an exhaustive list of high-income tax strategies, it does include some common methods for lowering the amount of your tax return. For a more personalized tax reduction strategy, you may want to consult a Gamburg CPA tax professional.