One of the most common questions our high income tax planning clients ask is how they can minimize their taxable income and maximize their tax deductions and tax savings, come filing season.
Between their business income and portfolio of investments, many of our high income earners face six and even seven-figure tax bills every April—so every dollar of tax savings helps!
While we customize our tax savings strategies to each client’s situation, many of our plans for high income earners leverage these three basic principles:
High Income Tax Strategy #1: Pay taxes as late as possible
Many taxpayers, when they get a tax bill, rush to pay taxes right away. But the time value of money principle suggests that the longer you can wait to pay tax (without incurring a penalty), the greater your potential to grow your wealth.
For example, business owners are required to make estimated tax payments throughout the tax year, with the full bill being due in April. To avoid underpayment penalties and interest, they must use those estimated tax payments to cover either 90% of the current year’s taxes or 100% of the prior year’s tax bill—whichever is less. (If you earn over $150K a year, those numbers jump to 100% of this year’s tax bill or 110% of last year’s bill, again, whichever is less).
By making your estimated tax payments based on whichever calculation is lower, you can avoid paying tax penalties and have your money working for you in the meantime. As long as you pay your final tax bill when your return is due, your money has even longer to grow.
This tax savings strategy highlights the importance of working with a tax planning professional who understands both tax law and how to generate tax-optimized investment income.
Learn more about our investment tax reduction strategies for high income earners.
High Income Tax Strategy #2: Reduce your taxable income
There are a variety of tax strategies for high income earners that a Cook Wealth tax advisor can recommend, based on your situation and tax bracket.
One of the most effective and rewarding tax reduction strategies is to increase your charitable contributions. Donating to qualified charities, like your church, local nonprofits, or national initiatives, reduces your taxable income and supports the causes you care about most.
Another of our favorite tax reduction strategies involves leveraging tax credits and tax deductions. Tax deductions do reduce your taxable income, giving you a new, lower adjusted gross income. And while tax credits don’t technically reduce your taxable income, they can significantly shrink your overall tax burden.
Here are a few of the tax credits and tax-deductible expenses our tax planning clients may qualify for:
- Business deductions. If you own a business, some of your home and vehicle expenses may be tax deductible. If you use your home for work or drive to meet clients, you may be able to deduct a portion of your utilities, cell phone bill, gas, and more.
- Electric vehicle credits. This year, a handful of American-made EVs are eligible for a tax credit of up to $7,500.
- Homeowner credits. In 2023, some energy efficient appliances and home upgrades qualify for a tax credit.
Each credit and tax deduction is subject to various income requirements and additional rules. That’s why it’s important to talk with your tax planning professional about what’s available to you, before you go buy an EV or increase your business expenses!
High Income Tax Strategy #3: Look for investments that grow tax-free or defer your federal income tax
Tax-efficient investments are some of the best tools high income earners can use to grow their wealth without growing their tax liability. While common investments like stocks and index funds can generate strong returns, the high capital gains taxes on these investments (which quickly rise as your tax bracket increases) can drag down your final return.
But when you contribute to these accounts, you can defer taxes until you withdraw your money in the future—or enjoy tax-free growth:
- Health Savings Account: If your employer offers this type of account, we almost always recommend cashing it out every year. As your account grows, you can invest this savings in a variety of funds and stocks—further boosting your tax-efficient growth. And not only do your Health Savings Account contributions reduce your taxable income and grow tax-free, all the money you deposit into this account can be used to cover qualified medical expenses, like doctor’s office visits and medications.
- 401(K) Plans: Contributing to tax-efficient retirement accounts, like your employer’s 401(K) plan, is a great way to increase your savings and defer tax payments until you’re in a lower tax bracket. Plus, 401(K) contributions are pre-tax, meaning they reduce your tax burden today while helping you save for the years to come.
- Tax-free Exchange Traded Funds (ETFs) and Municipal Bonds: Municipal bonds are tax-exempt bonds issued by city and state governments to fund community projects, like schools and highways. And the interest income generated from these bonds is generally exempt from both federal taxes and state income taxes. You can invest in municipal bonds individually, or purchase tax-free ETFs. These give investors the opportunity to invest in a diversified portfolio of municipal bonds.
This is a small list of the potential investment and savings tools our tax strategies for high income earners may include. Based on your tax rate, occupation, and state, there may be additional tax strategies we can consider to reduce taxable income and help you save for your family’s future.
At Cook Wealth, our tax strategies for high income earners reduce your tax bill—not your ROI.
Our personalized financial and tax strategies go beyond numbers to help you maximize your return on investment and your return on life.
To learn more about our holistic tax strategies and wealth management services, book a free intro call with our team.