After estate tax, federal income tax represents the most progressive part of the U.S. tax code. While low earners pay less income tax, higher earners pay significantly more. In fact, individuals that earn a lot of money from work or generate significant income from assets may end up paying around half of their earnings to the U.S. government. According to IRS data, high earners pay around 70% of total federal income taxes. Fortunately, high earners can utilize several tax reduction strategies to help reduce their income taxes in the future.
Ways to Reduce Income Tax Liability
Although many people mistakenly believe that reducing taxes cheats the government in some way, this isn’t true at all. The Internal Revenue Service (IRS) has no bias against high income earners that take advantage of strategies to legally reduce taxes.
While everyone should learn to reduce taxes whenever possible regardless of their income level, high earners cannot utilize the most common tax breaks. The IRS phases out these tax-savings opportunities for individuals earning a considerable amount of income. However, legal tax reduction strategies do exist for the very wealthy.
Currently, high earners pay 32%, 35%, and 37% tax rate. With proper tax planning, these individuals could reduce their tax liability. Without tax planning, high earners could end up paying much more than they need to on their federal income taxes.
Legally Reduce Taxes
The following tax planning strategies might help high earners legally reduce their income tax liability. However, it’s important to keep in mind that not all of these strategies will work for every taxpayer. It is strongly advised that high earners speak with an experienced wealth advisor prior to taking any action. A financial planning professional can help high earners locate opportunities for reducing taxes based on their unique situation.
Retirement Account Contributions
Deductions for most retirement account contributions do not have an income limit. However, this doesn’t apply if the taxpayer’s spouse has access to a 401(k) or other government sponsored retirement plan and also contributes to an IRA. In this case, the high earner only gets a tax break on the 401(k) and not the IRA.
Business owners can bypass the IRS deduction limitation by opening a SEP-IRA and making contributions as their own employer. The business owner can then write off the entire contribution as a business expense.
Mortgage Interest Deduction
One of the most popular tax breaks, the mortgage interest deduction, applies to home acquisition debt, or debt that is incurred as a result of borrowing to buy, build, or substantially improve a home. This tax break doesn’t just apply to a home owner’s first home, but also their second and third. The IRS allows individuals to take a mortgage interest deduction regardless of income. However, it’s important to note that the IRS recently placed a cap on new mortgages. The mortgage cannot exceed $750,000. This cap does not apply to existing mortgages.
Charitable Donations
Individuals that donate money or goods to verified charitable organizations can deduct the value of these contributions as itemized deductions. Although taxpayers can only deduct up to 60% of their adjusted gross income (AGI), there is no income limit to the charitable donation deduction. This makes charitable donations an excellent way for high earners to reduce income tax liability.
Long-Term Capital Gains
The IRS taxes short-term capital gains, or money earned from selling an investment less than one year after buying it, at the marginal income tax rate. Alternatively, the long-term capital gains tax rate cannot exceed 20%. Individuals in the top bracket could save around 50% in long-term capital gains taxes by holding onto their investments for one year or more.
Experienced Wealth Advisors
Depending on the specific situation, high earners may have additional tax breaks available to them as well. These individuals might want to consider seeking the help of an experienced tax planning professional.
Dechtman Wealth Management provides financial planning, investment management, and tax planning services to high earning individuals and families. Our team of experienced tax planning professionals works directly with each of our clients to help them locate opportunities to legally reduce their income taxes.
Please contact us for more information about our services.
