A high-income earner is an individual who earns a significant amount of income, typically above the average income level for their demographic.
In the United States, for federal income tax purposes, someone who earns more than $170,050 as a single person, a married person filing separately, or a single head of household, or more than $340,101 as a married person filing jointly is a high-income earner.
However, the definition of a high-income earner may vary depending on location, occupation, and industry.
The IRS does not have an official definition of a high-income earner. Still, the IRS does consider certain income levels subject to higher tax rates or additional taxes for tax purposes.
As of 2022, the highest marginal federal income tax rate for individuals is 37% and applies to taxable income over $523,600 for single filers and $628,300 for married filing jointly.
The IRS also applies additional taxes, such as the 3.8% Net Investment Income Tax, to individuals who earn above certain income thresholds. For Example, the Net Investment Income Tax applies to individuals who have modified adjusted gross income (MAGI) over $200,000 for single filers and $250,000 for married filing jointly.
High-income earners earn more than $170,050 as a single person, a married person filing separately, or a single head of household, or more than $340,101 as a married person filing jointly.
If you fall under this category, working with a skilled accountant or tax advisor is crucial for the best ways to approach local taxes, federal taxes, and overall tax planning.
In addition to taking your standard deduction and other deductions, there are many things you can do to lower the amount you pay. Here are five strategies for high-income earners to reduce their taxes:
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Change the Character of Your Income
Changing the character of your income is one way to reduce your tax burden. You can convert your SIMPLE, SEP, or traditional IRA to a Roth IRA if you are over the age of 59 1/2 and you meet the five-year rule.
Roth distributions are tax-free and will not increase your modified adjusted gross income (MAGI). MAGI is used to calculate the 3.8% Medicare surtax.
Business owners may want to restructure their business entity, mainly if they operate as a sole proprietor, LLC, or an S-Corp.
You should work with an accountant to determine if restructuring your business is worthwhile. Invest in real estate syndications and tax-exempt bonds, or invest in index mutual funds and exchange-traded funds.
These investments are an effective way to diversify the taxation of your income after retirement.
Another change of character is changing W-2 Income to Passive or Investment income.
W2 Income vs. Earned Income
Earned income is reported on a W-2 from labor at a workplace.
Earned income is subject to federal and state income tax and Social Security and Medicare taxes (also known as payroll taxes).
The tax rate for earned income is based on the individual’s tax bracket, determined by their total taxable income.
Earned income is the highest taxed income.
On the other hand, investment or passive income is earned from sources such as rental properties, stocks, bonds, and mutual funds.
Investment income is not earned through active work and is often considered “passive” because the individual is not directly involved in generating the income.
Investment income is subject to federal and state income tax and capital gains tax if the income is generated from selling an investment that has increased in value.
The tax rate for investment income can vary depending on the type of investment and how long the investment is held.
One key difference between earned income and investment income for tax purposes is how they are taxed.
Earned income is taxed at ordinary income tax rates, ranging from 10% to 37%, depending on the individual’s tax bracket.
Payroll taxes, which are Social Security and Medicare taxes, are also deducted from earned income.
On the other hand, investment income is subject to different tax rates depending on the type of investment and how long it is held. For example, long-term capital gains tax rates are lower than short-term capital gains tax rates, and certain types of investments may be taxed at a lower rate.
Another critical difference between earned and investment income is how they are reported on tax forms. Earned income is reported on a W-2 form from the individual’s employer, while investment income is reported on various tax forms depending on the type of investment.
For example, dividends from stocks are reported on a 1099-DIV form, while rental income is reported on a Schedule E form.
While both earned and investment income are subject to taxation, how they are taxed and reported on tax forms can differ significantly. It’s important to understand these differences to report and pay taxes on all types of income properly.
Max Out Your Retirement Contributions
High earners can take advantage of the tax-reducing benefits of their retirement plans by contributing the maximum amount.
For the tax year ending 2022, the maximum 401(k) contribution and 403(b) contribution is $20,500, while the maximum contribution for SIMPLE IRAs is $14,000.
Remember that if you are over 50, you may take advantage of catch-up contributions of up to $6,500 (401k) and $3,000 for 401(k) plans.
Roth IRAs are tax-free retirement accounts that can help you to reduce your tax burden and save money on your taxes, even if you are in one of the top brackets.
- Tax Benefits: Contributing the maximum amount allowed to your retirement accounts, such as a 401(k) or traditional IRA, can provide significant tax benefits. Contributions to traditional retirement accounts are made with pre-tax dollars, which can reduce your taxable income and lower your tax bill for the current year.
- Compound Interest: Retirement accounts are designed to help you save for the long term, and contributing the maximum amount allowed can help your savings grow significantly over time. With compound interest, your savings can grow exponentially as you continue contributing and earning interest on your existing savings.
- Employer Matching: Many employers offer matching contributions to retirement accounts, which can provide additional savings for your future. By contributing the maximum amount allowed, you can ensure that you take full advantage of any employer-matching contributions available to you.
- Retirement Readiness: Contributing the maximum amount allowed to your retirement accounts can help ensure you are financially prepared for retirement. With the rising cost of living and increasing life expectancy, it’s more important than ever to start saving early and make the most of your retirement contributions.
- Lowering Your Taxable Income: Contributing the maximum amount allowed to your retirement accounts can also help lower your taxable income, providing additional tax benefits. By reducing your taxable income, you may be eligible for additional tax credits or deductions, which can lower your overall tax bill.
- Flexibility: Retirement accounts offer flexibility regarding when and how to access your savings. While there are penalties for withdrawing funds before age 59 ½, you can generally access your retirement savings penalty-free once you reach this age. This can provide a reliable source of income in retirement and give you the flexibility to manage your finances according to your needs.
Fund 529 Plans for Your Children
You may be eligible for tax credits such as the Child or Earned Income Tax Credit. These credits can reduce your tax liability dollar-for-dollar.
529 Tax-Advantaged Plan
A 529 tax-advantaged savings plan is designed to help families save for future education expenses. The benefits of a 529 plan include the following:
- Tax Advantages: Contributions to a 529 plan are made with after-tax dollars, but the earnings grow tax-free. When the funds are withdrawn to pay for qualified education expenses, they are tax-free. This can result in significant tax savings over time, particularly for families who start saving early and allow their investments to grow.
- Flexibility: 529 plans are designed to be flexible and can be used for various educational expenses. This includes tuition, fees, books, room and board, and even some K-12 expenses in certain states. In addition, the funds can be used at any eligible college, university, vocational school, or other post-secondary institution in the United States, as well as some international schools.
- High Contribution Limits: There are no annual contribution limits for 529 plans, and many plans have high lifetime contribution limits that can exceed $300,000 per beneficiary. This allows families to save significant money for their children’s education.
- Anyone Can Contribute: Anyone can contribute to a 529 plan, regardless of their relationship to the beneficiary. This means grandparents, aunts, uncles, and even family friends can contribute to a child’s education savings.
- Low Impact on Financial Aid: Regarding financial aid, 529 plans are treated favorably. The assets in a 529 plan are considered an asset of the account owner (usually the parent), not the beneficiary (the child). This means that the impact on financial aid eligibility is relatively low and may be excluded altogether in some cases.
- Estate Planning Benefits: For families with significant assets, a 529 plan can be a valuable tool for estate planning. Contributions to a 529 plan can be considered a gift for tax purposes, which can help reduce the donor’s taxable estate. In addition, some states offer additional tax benefits for estate planning purposes.
Overall, a 529 plan can be valuable for families who want to save for their children’s education. With tax advantages, flexibility, high contribution limits, and low impact on financial aid, a 529 plan can help families save for education expenses while providing other financial benefits.
Invest in Businesses that Pay Dividends
Investing in companies that pay qualified dividends can provide tax benefits since the maximum federal tax rate for qualified dividends is 20%.
Investing in commercial real estate syndications allows you to have ownership shares and dividends that the depreciation can deduct.
Real estate syndications are a type of investment where a group of investors pools their resources to purchase, manage, and operate real estate properties. Syndications are typically structured as limited liability companies (LLCs) or limited partnerships (LPs), with one or more general partners or sponsors managing the investment.
Investing in real estate syndications can provide several benefits for investors, including:
- Diversification: Real estate syndications allow investors to diversify their investment portfolios by investing in various properties and markets. By pooling their resources with other investors, they can access opportunities that may not be available individually.
- Passive Income: Real estate syndications allow investors to earn passive income from rental properties or other investments. As a limited partner, investors typically receive a share of the profits from the investment without having to manage the property actively.
- Professional Management: Real estate syndications are typically managed by experienced real estate professionals with the expertise to identify and manage high-quality properties. Investors can benefit from this expertise without having to manage the property themselves.
- Tax Benefits: Real estate syndications can offer tax benefits to investors, including depreciation deductions and the ability to defer or reduce taxes on capital gains through like-kind exchanges.
- Access to Larger Investments: Real estate syndications allow investors to participate in more prominent real estate investments than they can afford. This can provide access to higher-quality properties and potentially higher returns on investment.
- Limited Liability: As limited partners, investors in real estate syndications have limited liability for the debts and obligations of the investment. This can help protect their assets in case of any legal or financial issues with the investment.
It’s important to note that investing in real estate syndications does come with risks, such as the potential for fluctuations in the real estate market, changes in local zoning or tax laws, and the potential for loss of capital.
It’s essential for investors to thoroughly research and vet any real estate syndication opportunities before investing and to work with a trusted financial advisor or real estate professional.
Real estate syndications can offer investors the opportunity to diversify their portfolios, earn passive income, access professional management and expertise, receive tax benefits, participate in more significant investments, and have limited liability.
High-income earners can reduce their taxes by taking advantage of various tax breaks.
Donate to Charity
Charitable contributions are the most straightforward tax cuts. The IRS offers a dollar-for-dollar reduction for charitable donations to qualified charities. High-income earners or high-net-worth individuals may also consider a Charitable remainder trust.
A charitable remainder trust (CRT) is an irrevocable trust that allows the trust creator, or grantor, to provide income to one or more non-charitable beneficiaries for a specified period, with the remaining assets ultimately distributed to one or more charitable organizations.
The trust is designed to generate income for the beneficiaries while providing significant tax benefits and supporting the grantor’s philanthropic goals.
In corporate America, we are often bound by “Golden Handcuffs” or payment structures such as commission checks or high-paying bonuses over our actual salary.
Bonuses and Commissions are taxed at a higher rate than regular W-2 wages. Ensuring our overall tax burden is limited is reduced to keep what we have worked for takes planning.
By changing the character of your income, maxing out your retirement contributions, taking advantage of tax credits, investing in real estate, and investing in businesses that pay dividends, you can significantly reduce your tax burden.
Working with a skilled accountant and financial advisor can help you navigate these tax-saving strategies and ensure you make the most of your income.