Taking advantage of generous tax benefits is especially advantageous for the wealthiest Americans, who are also those who pay the most in taxes. A large sum of money may be saved on taxes for persons earning $100,000 or more by making use of tax laws that favor them.
Phase-out provisions prohibit persons with higher incomes from taking full benefit of many tax reductions. For those who make more than $100,000 a year, the following tax incentives are available, and they may reduce your tax payment significantly.
Tax Deductions Vs. Tax Credits
The most enjoyable aspect of completing their taxes for many people is taking advantage of tax credits and tax deductions. It's possible to lower your tax burden in a variety of ways:
● When you claim a tax credit, you get a dollar-for-dollar decrease in the amount of tax you have to pay. For example, a $10,000 tax credit decreases your tax burden by the same amount.
● Tax deductions minimize the amount of your income that is taxed. Deductions reduce your taxable revenue by the proportion of your highest federal income tax bracket that you've already paid taxes on. For those in the 22% tax bracket, a $10,000 deduction means you'll save an additional $2,200.
All taxpayers can itemize mortgage interest and state and local property taxes, but the value of those deductions is greater for higher-income taxpayers. If you are in a higher tax bracket, a deduction will have a more significant impact on your tax bill than if you are in a lower bracket, such as 15% or 25%. Because high-earners tend to purchase homes that generate a lot of interest and taxes, they are more likely to exceed the standard deduction amount than a middle-earner.
These and other itemized deductions can be paid with a single check. Depending on your filing status, it is possible to lose as much as 80% of your qualifying deductions if you make more than $250,000 or $300,000 under the new rules. 3% of excess income beyond the threshold is phased off—up to a maximum of 80% of that amount. These deductions may still significantly impact the wealthiest Americans, notwithstanding these decreases.
Long-Term Capital Gains and Low Tax Rates on Dividends
High-income taxpayers benefit disproportionately from tax benefits reserved for investment professionals. The maximum tax rates for qualified dividends and long-term capital gains are much lower than the usual income tax rates. The maximum deductible tax rate on capital gains and dividend income for taxpayers in the 25% to 35% tax bands is 15%.
The 39.6% tax bracket is subject to a higher 20% tax rate. To illustrate, this provision saves just ten percentage points of tax for taxpayers in the 25% tax bracket, but it saves 13 to 20 percentage points of tax for those in the 28%, 33%, and 35% tax brackets, respectively. With a 19.6 percentage point break, taxpayers in the top bracket do virtually as well as they would have otherwise.
This low-tax income group is simpler for affluent taxpayers to get because of their greater tendency to invest. If you earn more than $100,000 a year, you're likely already paying a significant amount of tax. Take advantage of these options to save money and retain more of your hard-earned money for yourself.
Take Advantage of Tax Law Changes
A large number of tax reduction options are available to high-income earners who are interested in saving money on their taxes. However, if you are considering putting in the extra effort, or if you're working with a knowledgeable financial counselor, you may reap the benefits.
It may be difficult for high-income individuals to keep up with the ever-changing tax regulations. Tax Cuts and Jobs Act 2017 was the most significant reform of the tax system for decades. New tax laws reduced income tax rates by a few percentage points for numerous tax bands.
Individual and joint filers alike have received an increase in the standard deduction as a result of the temporary tax adjustments. Those with high incomes will have a stricter time itemizing their deductions after the new, higher standard deduction in 2021, which will be $12,550 for single taxpayers and $25,100 for joint filers.
To help taxpayers in times of uncertainty, the SECURE Act of 2019 and the Taxpayer Certainty and Disaster Tax Relief Act of 2019 were signed into law in December.
New Tax Legislation and Basics of Tax
First, you should familiarize yourself with the tax brackets, which determine the amount of money you pay in taxes. You owe the IRS a percentage of the taxable income you earn; this is not the same as your adjusted gross income. A person's adjusted gross income (AGI) is the sum of their total gross income less any deductions authorized by the Internal Revenue Service (IRS).
To put it another way, taxable income is gross income less personal exemptions and itemized deductions, often known as below-the-line deductions, as well as any other adjustments. Those who make a lot of money should constantly be aware of the tax consequences of their next dollar of earnings.
Depending on your taxable income, federal tax rates will fall into one of the groups in the following section beginning in 2021.
Above the Line Deductions
Regardless of if you choose to itemize or take the typical deduction, deductions over the line may lower taxable income. Reducing your AGI (Adjusted Gross Income) may allow you to qualify for extra tax deductions or credits, so it's critical to take advantage of any available above-the-line deductions. The following are possible above-the-line deductions for those with high incomes:
Contributions to Health Savings Account
HSAs are tax-advantaged accounts in three ways: a tax-deductible contribution is made, the money grows tax-free, and any withdrawals are tax-free for eligible medical costs for individuals under the age of 65 and any reason for those aged 65 and above. Individual contribution limitations are $3,600 and $7,200, respectively, for singles and couples. A $1,000 bonus is available to anyone over the age of 55.
Traditional IRA Contributions are Tax-Deductible
Withdrawals from a Traditional Individual Retirement Account (IRA) may be tax-deductible depending on whether or not you have access to a group retirement plan. You and your spouse may use the deduction if you don't have access to a group plan. A married couple with just one spouse having access to a group retirement plan may deduct payments up to $198,000 to $208,000 in Modified Adjusted Gross Income (MAGI). The MAGI maximum for the deduction is $105,000 to $125,000 if both spouses have access to a group plan. The MAGI limit for a single individual who has access to a group retirement plan is $66,000 to $76,000.
Contributions to a Qualified Retirement Account
Firms often offer qualified retirement savings programs such as 401(k), 403(b), and 457 plans to entice potential workers. A straightforward approach to save money on taxes for high-income individuals is to enroll in one of these programs via your workplace. Your taxes aren't affected by reductions since they're taken out of your check in the first place. Net of pre-tax contributions to a retirement plan, the income reported on the 1040 form is the same as the sum reported on the tax return.
Charitable Donations Meeting the Requirements of the Law
A qualified charitable distribution (QCD) is a payment made directly from an IRA to a qualifying charity by a person who is at least 70 years old. The Internal Revenue Service (IRS) permits you to make tax-deductible contributions to organizations such as your church or favorite charity through your IRA. If you're inclined to give, a QCD might save you tens of thousands of dollars in taxes.
Below the Line Deductions
Once your AGI (Adjusted Gross Income) has been calculated, below-the-line deductions (also known as standard deductions or itemized deductions) are established. Certain deductions don't cut your taxable income at all. About 90% of taxpayers are expected to use the standard deduction instead of itemizing their expenses.
There will be a $12,550 standard deduction for individuals and a $25,100 for married couples filing jointly. The same can be said for a more significant deduction for the blind and those aged 65 or older.
How to Save Money on Taxes
For high-income taxpayers, itemizing deductions is far more complicated than it was in the past. There is definitely room for savings when you plan ahead and itemize your deductions. To save money on taxes, consider these options:
There are various options available to assist you in maximizing your tax deductions. High-income individuals might consider giving low-cost shares, contributing to a donor-advised fund, or stacking future charitable contributions in a single year to maximize tax return.
Mortgage Interest Expenses
Consider cash-out refinancing or buying a property to deduct your mortgage interest if you presently rent or have a lot of credit card debt or large remaining student loans. An amount of up to $750,000 in mortgage interest may be deducted from taxes.
Monitor your medical costs. You may be able to remove some of your medical expenses even if you're in good health because of bigger families or past illness issues. An itemized deduction is available for medical costs that exceed 7.5% of your adjusted gross income (AGI) beginning in 2021.
Income Deferral or Acceleration
It's not always the best strategy to delay or accelerate taxable pay, but it may help you save on your income and capital gains taxes, as well as the Medicare surcharge of 3.8% on investment income.
Revenue deferral isn't only about delaying the current year's income; it's also about delaying future income. In order to maximize your savings and assets, tax-savvy people use a long-term income deferral approach.
You should bear in mind that the current tax rates are set to expire in 2025, so any money you postpone currently may really be taxed at a higher rate in the future if you don't plan ahead.
Essential Income Strategies to Consider
● Consider contributing to a non-qualified deferred salary: A deferred compensation plan may help you lower your taxable income this year while increasing your post-retirement financial security.
● Consider delaying your salary: You've had a great year for commissions, right? As a result, your taxable income may rise this year over the following year. Request a delay in payment from your company if you expect to receive commissions or other forms of earned income. Your tax bill will likely be less if your taxable income is lower next year, thus delaying your income might minimize your tax burden.
● IRA withdrawals may be delayed or accelerated after retirement: Due to your tax rate and the amount of money in your retirement account, you may be better off taking early or delayed Individual Retirement Account (IRA) withdrawals. For example, with a higher tax rate in the future, changing standard IRAs to Roths may make financial sense. Because of this, you could consider deferring the distributions of your IRA to lower your taxable income. Either of these options may help you lower your taxable income in retirement by lowering your tax brackets over time.
Income Tax Deferral
Tax-deferred investment vehicles, such as Roth IRAs and Health Savings Accounts (HSAs), are not the same as tax-exempt ones; there will be tax ramifications when the assets are distributed. For high-income individuals, tax-deferred accounts may be an effective method for reducing current year tax payments. However, tax-deferred accounts also benefit from quicker compounding of returns due to the absence of current taxes on the income. There are three tax-deferred investment vehicles as follows:
Deferring investment income via a 401(k), 403(b), or 457 plan is one of the simplest ways to do so. Specifically, the SECURE Act allows high-earning individuals over the age of 50 to invest up to $26,000 per year in a 401(k) to better plan for retirement. You won't be taxed on dividends, interest, or capital gains until you take a distribution from the account at age 59 or later, as long as they are held in a tax-sheltered account.
529 Plans for Education
On the other hand, you pay federal income taxes on your contributions, but the money grows without being taxed. Any contributions above $15,000 per donor per beneficiary count towards the lifetime estate and gift tax exemption. There are no yearly restrictions.
People who wish to discover how to lower their state income tax may deduct up to $4,000 per account every year. It is now possible to utilize these funds to pay for private school tuition of up to $10,000 per year for students with these accounts.
Cash-Value Life Insurance
Due to larger investment restrictions, this is one of the most popular tax deferral schemes for high-income individuals. Withdrawals up to the sum of premiums remunerated are tax-free, while contributions are taxed at a lower rate.
Reform the Character of Your Income
Changing the assets in your portfolio might significantly impact your tax bill. Changing the form of your firm may be an excellent tax-cutting approach for high-income individuals who own a business. Here are a few options:
Convert Your Simple IRA to a Roth
Roth distributions are normally tax-free beyond the age of 59. Additionally, they don't count against your MAGI for the 3.8% Medicare surtax. Your federal taxes rates will need to be examined, although minimizing your future taxable income via Roth conversions is possible.
Buy Bonds With Tax Exemption
Income from tax-exempt bonds is not included in Medicare surtax calculations and is not subject to federal income taxes. Better still, if you buy municipal bonds in your home state, you won't have to pay federal or state wage taxes on the interest.
Restructure Your Business Character
Once your firm has been formed, you can choose an appropriate tax structure. There is a lower tax rate for C-corps than for S-corps or sole proprietorships. As a result, a new deduction of up to 20% of company income may also be available to pass-through entities.
When you run a sole proprietorship, you don't have to worry about withholding or matching payroll taxes for your young children. Children's income is taxed at a lower rate than that of adults.
Invest Your Health Savings Account (HSA) Contributions
Many high-income people either don't utilize an HSA or misuse it. Health Savings Account (HSA) payments may be invested for the long term rather than used for current medical bills if you are eligible. If spent on a qualifying medical cost, subsequent payouts are tax-free.
Buy Index Funds and ETFs
In order to decrease your tax bill and magnify your returns, this is the way to go. Every high-earning individual should have a strategy in place to minimize the tax burden on their post-retirement income. Tax-efficient index mutual funds and/or ETFs may help you save money on your annual investment taxes if you have taxable accounts. There might be tax benefits to investing in ETFs and index funds rather than actively managed funds.
Timing is Everything
Managing the timing of significant profits to avoid the Medicare surtax and the 20% capital gains bracket is an important part of effective tax planning for high-income earners.
Three Tips to Manage Your Gains
Establish a Charitable Remainder Trust
Some trusts provide money to beneficiaries for a certain length of time before the rest is given to charity. You may avoid paying taxes on the value of your long-term, appreciated asset and get a tax credit based on the present worth of the gift by making a donation.
A Qualified Opportunity Fund (QOF) is a Good Investment
Within 180 days of a sale, you may delay capital gains taxes until 2026 by putting them in a qualified opportunity fund (QOF). Holding onto an investment for a minimum of five years reduces your taxable income.
Take Advantage of Your Assets' Unrealized Losses
Sell any investments in taxable accounts that have lost money when the stock market falls. You may take advantage of a method known as tax-loss harvesting by selling your assets. As of 2021, the IRS will enable taxpayers to deduct up to $3,000 in losses against their regular income and allow them to balance losses with current and future year capital gains. It is possible to carry over any losses that are not utilized in the current year.
High Income Does Not Always Mean High Taxes
As you can see, there are quite a number of tax breaks and benefits for high-income earners who earn above 100k. Opportunities to save on tax may pass you by if you are not aware of these options. Contact a professional to help you stay abreast of what taxes you can save on, especially those based on your residency.
Moreover, should you need your tax documents sent in, you can enlist a mail forwarding service to guarantee your tax return gets to its destination on time.