High earners often face significant tax liabilities due to their substantial incomes. Taxes are only increasing on these earners, and it’s easy to feel the squeeze of this kind of financial burden.
However, there are legitimate and effective strategies that can help reduce taxable income. These strategies can allow them to keep more of their hard-earned money.
What are some insider tips that high earners can use to legally minimize their tax burden? How can they optimize their financial situation? Read on, and we’ll walk you through what you need to know about how to reduce taxable income for high earners.
Maximize Retirement Contributions
One of the most powerful methods for high earners to decrease taxable income? By contributing the maximum allowable amount to retirement accounts.
Traditional Individual Retirement Accounts (IRAs) and 401(k) plans enable individuals to make tax-deductible contributions. This can effectively lower their taxable income by the contribution amount.
As of 2023, the annual contribution limit for 401(k) plans stands at $20,000 for individuals under 50 and $26,500 for those aged 50 and above. For traditional IRAs, the contribution limit is $6,500 for individuals under 50 and $7,500 for those aged 50 and above.
Back Door Roth IRAs
High earners might find themselves ineligible to contribute straightforwardly to a Roth IRA. This would be due to income limits.
Nevertheless, they can still benefit from a “Backdoor Roth IRA” strategy.
This includes creating a non-deductible benefaction to a conventional IRA. Then, after this action, convert it into a Roth IRA.
Although the initial contribution is not tax-deductible, the converted amount is not subject to taxes. This allows for tax-free growth and withdrawals in the future.
Utilize Health Saving Accounts
HSAs are tax-advantaged accounts designed to assist individuals with high-deductible health plans in covering medical expenses.
Contributions to HSAs are tax-deductible. Withdrawals for qualified medical expenses are tax-free.
High earners can take advantage of contributing to an HSA to lower their taxable income. All the while, they will be saving for future medical needs.
Invest In Municipal Bonds
Another great way to reduce taxable income? Invest in municipal bonds.
Investing in municipal bonds can be an attractive option for high earners seeking to reduce their taxable income.
Interest earned from municipal bonds is typically exempt from federal income tax. Sometimes from state and local taxes as well. Evaluate the overall tax-equivalent yield to align these bonds with your financial goals.
If you need help with back taxes this is a great way to go about it.
Deducting Business Expenses
One of the best tax strategies for high-earners is to consider their business expenses.
This is a crucial aspect of tax planning for those who have their own businesses. By properly identifying and deducting eligible business expenses, high-earners can significantly reduce their taxable income.
What Are Business Expenses?
Business expenses are costs that are necessary for the operation of a business. Ordinary expenses are common and accepted in the industry, while necessary expenses are those that are helpful for your business operations.
Eligible expenses can include office supplies, rent for business premises, and travel expenses related to business. It can also mean marketing and advertising costs, professional fees, utilities, equipment purchases, and more.
Earners who operate their businesses from a home office may also qualify for the office-home deduction. Such a deduction paves the way for a deduction of a small part of home-related expenses. This could be things like insurance, mortgage interest, property taxes, as well as utilities.
How much one can deduct will be based on the percentage of the home used for business purposes. The IRS has specific guidelines for claiming this deduction. For this reason, it’s essential to understand the rules thoroughly.
Proper record-keeping is critical when it comes to deducting business expenses. Maintain accurate and organized records of all business-related transactions. Keep receipts.
Having well-documented records will not only help you claim the deductions you’re entitled to… it will also ensure compliance in case of an audit.
Tax Loss Harvesting
Tax-loss harvesting is a strategy to offset capital gains with capital losses. It’s a great way to reduce taxable income.
By selling investments that have experienced a loss? High earners can offset gains from other investments. This lowers the overall taxable income needed.
How Does It Work?
When an investor sells an investment at a profit, it generates a capital gain. This gain is subject to taxation.
However, by selling an investment when facing a loss, investors can use that loss to offset capital gains. By doing this, they reduce the amount of taxable income from the gains.
This can lead to a lower overall tax bill for the investor.
In case the entire capital loss exceeds a year’s capital gains, the exceeding losses will be taken forward in coming years to combine with offset gains. This is known as “loss carryforward.”
It allows investors to maximize the benefits of tax loss harvesting over multiple years.
Tax loss harvesting can be seamlessly integrated into a portfolio rebalancing strategy. As investors rebalance their portfolios to maintain their desired asset allocation, they can simultaneously identify opportunities for tax loss harvesting by selling certain assets that have experienced losses.
How To Reduce Taxable Income For High Earners
Are you tired of seeing a large chunk of your income go toward taxes each year? The above tips on how to reduce table income for high earners can help you get out of this frustrating situation.
Becoming financially literate in these matters can help to ensure more money stays in your pocket each year. It can help combat the problems of tax season.
Have more questions about financial planning? Need more advice on paying taxes? Keep scrolling through our blog for more.