Tax strategies for high earners

Tax planning is a crucial aspect of financial management for everyone. But high-income earners, who have well above average income levels, face higher tax rates and more complex tax situations than average taxpayers. For example, in 2020, the top 1% of income earners paid 42.3% of all federal income taxes, while the bottom 50% contributed 2.3%.

Moreover, high-income earners are subject to additional taxes, such as the net investment income tax, the Medicare surtax, and the alternative minimum tax, that can further increase their tax burden. Therefore, it is essential for high earners to find ways to minimize their current and future tax liabilities, while maximizing their wealth accumulation.

One of the most effective ways to achieve this goal is to take advantage of vehicles for future tax-free income. These vehicles allow high-income earners to reduce their taxable income now, defer or avoid taxes on their investment earnings, and enjoy tax-free income in retirement or for medical expenses. If you’re an HE or HNWI looking to reduce your tax liability while planning ahead, we’ll explain how these vehicles work and how to implement them effectively.

Options that may fit your needs

High earners can benefit from tax strategies that not only manage but optimize their financial situation. Key among these strategies is the ability to defer taxes on realized gains, ensuring your wealth works harder for you. However, there are other pivotal tax strategies for high earners that can lead the way to a more secure and prosperous financial future.

Future Tax-Free Income Strategies

Roth Conversions and HSAs: High earners should consider Roth IRA conversions to pay taxes now at potentially lower rates, securing tax-free withdrawals later. Health Savings Accounts (HSAs) also offer a triple tax advantage: deductible contributions, tax-free growth, and tax-free withdrawals for medical expenses, reducing current taxable income and providing future tax-free funds.

Roth 401(k) Contributions: For those in high tax brackets, it’s important to take advantage of the lower rates under the Tax Cuts and Jobs Act before they sunset in 2025. Opting for a Roth 401(k) allows for tax-free withdrawals in retirement, without current income limits, offering a hedge against future tax rate increases.

Portfolio Management

Tax-Loss Harvesting and Efficient Vehicles: Tax-loss harvesting allows investors to offset realized gains with losses, potentially reducing taxable income. Incorporating individual stocks into your portfolio, as opposed to solely relying on mutual funds or ETFs, affords greater control over the timing of gains and losses, enhancing tax efficiency.

Direct Indexing: Direct Indexing replicates index performance with individual stocks, allowing for personalized tax-loss harvesting and potentially higher after-tax returns. This strategy can be particularly effective for benchmark-conscious investors, offering the potential for higher after-tax returns over time.

Charitable Giving Strategies

Appreciated Stock and Donor-Advised Funds: Charitable giving can be both altruistic and tax-efficient. Donating appreciated stock can eliminate capital gains tax on the donated shares, providing an immediate tax deduction if you itemize. Donor-Advised Funds (DAFs) allow for tax-efficient, flexible charitable contributions, potentially increasing the impact of donations.

Realized Gains Tax Deferral

1031 Exchanges and Opportunity Zone Investments: Real estate investors can defer capital gains taxes through 1031 exchanges by reinvesting proceeds into new properties. Furthermore, investing in Qualified Opportunity Zones can defer and potentially eliminate taxes on capital gains, though risks must be carefully weighed.

Is your CPA giving you the right guidance?

There are a variety of tax strategies for high earners that not only mitigate their current tax burden but also help secure their financial future. The key is to adopt a holistic approach, considering the interplay between various tax vehicles and strategies, and consult with qualified tax professionals when needed. This way, you can handle tax planning with confidence, making sure your financial decisions today align with your long-term goals and give you peace of mind in a changing tax environment.

Looking for one of the best CPA firms around? Wondering how to fire your accountant? GYL provides a full range of accounting, audit, business advisory and tax services for businesses, not-for-profits and individuals. Contact GYL today and see how we can make your finances work for you.