11 Ways for High Earners to Reduce Taxable Income [2023]

This post was originally published on December 17, 2021, and extensively updated
January 30, 2023

When you earn a high income, you tend to pay a higher percentage of taxes than average earners. If you're a high earner, you might think you have no choice—that you must resign yourself to bearing a high tax burden. But is that really the case?

The short answer is NO.

At CMP, we spend a lot of time with our clients, including clients with sizable incomes, discussing and working on proactive tax planning. In fact, one of the most common questions we hear is this:

What’s the best way to reduce taxable income? 

or you may be wondering...

How to reduce taxable income

Don't worry. We will cover all that and more in this blog post.

The more money you make, the more complicated your taxes are going to be. So, if you have a higher income than most people, it’s important to work with a skilled accountant to figure out how to reduce the amount of income taxes you pay. In addition to taking your standard deduction and other deductions, there are many things you can do to lower the amount you pay.

Overview of Tax Rules for High-Income Earners

If you're reading this blog post, you likely want to read about the best tax deductions for high income earners. We'll get to that. But first, let's start with an overview of tax rules for high-income earners.

The SECURE Act, which became law at the end of 2019, has several provisions that apply to high-income earners, including the following:

• Raising the age for Required Minimum Distributions (RMDs) from retirement plan accounts to 72 (however, if you turned 70 1/2 in 2019, you were required to take a disbursement in 2020).
• Eliminating the age limit for contributions to Traditional IRA accounts.
• Increasing annual contribution limits for 401(k) and 103(b) accounts to $19,500 and to $13,500 for SIMPLE IRAs. The contribution maximum for Traditional and Roth IRAs will increase to $6,500 per year, effective 2023.
• Increasing the Social Security wage base to $142,800.
• Increasing the income ceiling for Roth IRAs. Contributions now phase out at $125,000 and $140,000 of modified adjusted gross income. ($198,000 to $208,000 if you're married and filing jointly).
• Increasing limits for long-term care premium deductions to $5,640 per person for people aged 71 or over and to $4,520 for people between the ages of 61 and 70. Self-employed earners may write off 100% of their premiums using Schedule 1 of the 1040 form.

These changes are significant because they make it possible for high-income earners to make additional contributions to a retirement plan during the tax year. Later in this post, we will review potential changes that may affect high earners.

2023 Federal Income Tax Brackets

For 2023, there are seven income tax brackets. Here’s how they break down.

IRS Definition of High-Income Earners

For tax purposes, the IRS defines high-income earners as anybody who earns enough income to be in the top three tax brackets, as outlined above.

That means if you earn more than $170,050 as a single person, a married person filing separately, or a single head of household, or more than $340,101 as a married person filing jointly, you are considered a high-income earner for tax purposes.

Tax Saving Strategies for High-Income Earners: Change the Character of Your Income

One way to reduce your tax burden is to change the character of your income. If you're wondering why you should do so, here are some of the ways it can help you to lower your tax bill.

• Convert your SIMPLE, SEP, or traditional IRA to a Roth IRA. If you are over the age of 59 1/2 and you meet the five-year rule, Roth distributions are tax-free. Because they are not considered investment income, they will not increase your modified adjusted gross income (MAGI), which is used to calculate the 3.8% Medicare surtax.
• If you own a business, you may want to restructure your business entity, particularly if you are operating as a sole proprietor, LLC, or an S-Corp. The taxes for a C-Corp are lower at the top than for other business structures. However, there is also a new 20% deduction of business income for pass-through entities. If you hire your children, you may be able to pay them without withholding or matching payroll taxes if you have a sole proprietorship. You should work with an accountant to determine if restructuring your business is worthwhile.
• Invest in tax-exempt bonds. Any interest you earn is not subject to federal income tax and Medicare surtax calculations. Also, municipal bond interest for bonds purchased in the state where you live is exempt from state income taxes.
• Consider investing in index mutual funds and exchange-traded funds. These funds are not actively managed and, as a result, can be more tax-efficient than managed funds. These investments are an effective way to diversify the taxation of your income after retirement.
• If you qualify for a Health Savings Account, you have the option of investing the funds in the account instead of spending them on medical expenses. Contributions are tax-free, and earnings grow tax-free. In addition, if you use future distributions to pay for qualified medical expenses, the distributions are tax-free.

The overall benefit of changing the character of your income is that it can reduce your MAGI for each tax year and allow you to take advantage of a lower tax bracket in some cases.

The good news is that with a combination of tax deductions, tax credits, and contribution strategies, you can reduce your tax bill by reducing your taxable income. Here are 11 ways to accomplish your goal and reduce your tax bill.

1. Max Out Your Retirement Contributions

Let’s start with retirement accounts. Employer-based accounts such as 401(k) and 403(b) accounts allow you to lower your taxable income easily. That’s because every dollar you put into these accounts is not taxed until you withdraw the money from your account—and that reduces your tax burden each year you contribute.

The benefit here is that if you wait until you have retired to withdraw money from your 401(k), your income will be lower because you will no longer be drawing a salary. The result? You will be in a lower tax bracket. This means that the money you withdraw will be taxed at a much lower rate than it would have been if you had to pay taxes when you earned it.

You can take advantage of the tax-reducing benefits of retirement accounts by contributing the maximum amount. For 2022, the maximum 401(k) contribution and 403(b) contribution is $20,500, while the maximum contribution for SIMPLE IRAs is $14,000. Keep in mind that if you are over the age of 50, you may take advantage of catch-up contributions of up to $6,500, as well (401k), and $3,000 for 401(k) plans.

2. Roth IRA Conversions

Roth IRAs are tax-free retirement accounts that can help you to reduce your tax burden and save money on your taxes, even if you are in one of the top brackets. Unlike a traditional IRA, Roth IRA contributions are made from post-tax income. That means you will pay taxes before you contribute but not when you withdraw.

That might not seem like an advantage, but it is. Any income earned on money in your Roth IRA is also tax-free. You can even roll over the money in a traditional IRA or a 401(k) into a Roth IRA and reap the same benefits.

Some of the best times to do a Roth IRA conversion are when you have had a year with less income than the previous year or when you have retired and are temporarily in a lower tax bracket. This strategy makes sense if you can wait until the age of 72 to make mandatory withdrawals. We like to suggest this option to our clients because it is easy to overlook, especially when people are focused on tax deductions as a way of reducing their taxable income.

3. Buy Municipal Bonds

Municipal bonds might not be the most glamorous investment, but we often recommend tax-exempt bonds to our high-income clients. When you buy a municipal bond, you lend money to the issuer in exchange for set interest payments throughout the bond. At the end of the period, the bond is mature, and the original investment is returned to the buyer.

The income from tax-exempt bonds is usually exempt from all income taxes, including federal, state, and local taxes. Even the interest payments from the income may be exempt from taxes.

Of course, municipal bonds usually earn less income than other taxable bonds, but they can still be a worthwhile strategy for reducing your tax burden. You can decide whether they are worth it by calculating the bond’s tax-equivalent yield.

4. Sell Inherited Real Estate

If you have inherited real estate from a parent or someone else, you may not realize that you can save money on property taxes by selling the real estate quickly. Here’s why:

Let’s say your parents bought a home for $200,000, and it is now worth $900,000. If they had sold it while they were alive, they would have paid capital gains on $700,000. If you hold onto the house, you will have a stepped-up tax basis of $900,000 and will be required to pay property taxes on that amount, thus significantly limiting your potential gain from the sale. The goal is to minimize your capital gains tax liability.

The alternative is to sell the home quickly after you inherit it, thus saving money on property taxes and maximizing your inheritance. Of course, you should also know that you can avoid capital gains tax by rolling the income from the sale into another real estate investment within 180 days (1031 exchange).

5. Set Up a Donor-Advised Fund

You already know that donating money to charity offers the opportunity for a tax deduction in the year the donation is made. What you may not know is that you can get a deduction this year for several years’ worth of contributions if you set up a donor-advised fund.

A donor-advised fund is a charitable fund you can set up that allows you to decide how and when to allocate funds to individual charities. You can make contributions this year and take the full tax deductions this year on your tax return, thus reducing your tax bill. Then, going forward, you can decide how much money to donate per year and where to donate it. In short, you receive the tax deduction when you fund the donor-advised fund.

We often recommend this strategy to our high-income clients, especially if they have a year with higher-than-normal income due to an inheritance or windfall. It is a clever way to use charitable deductions to your advantage.

6. Use a Health Savings Account

You may also choose to contribute some income to a Health Savings Account (HSA) to save on your taxes. You may contribute only if you have selected a high-deductible insurance plan. For 2022, the maximum contributions are:

• $3,650 for individuals
• $7,300 for families

 You may contribute an additional $1,000 if you are 55 or older. HSA contribution limits are linked to inflation, even though cost increases for medical expenses typically outpace inflation every year. For 2023, the maximum is increasing to $3,850 for individuals and $7,750 for families.

You can use the money in your HSA for medical and dental expenses and related costs, such as over-the-counter medications and first aid supplies. If you withdraw money and use it for non-qualified expenses, then you will pay tax on your withdrawals.

You should know that the money in your HSA is yours forever, unlike the money you contribute to a Flexible Spending Account, which must be spent during the tax year. For that reason, you may want to consider an HSA. You will need to weigh the risks of having a higher deductible against your potential savings.

7. Invest in Companies that Pay Dividends

The income that you earn from your job is taxed at ordinary income rates, and the result is that you pay a high tax rate if you are a high earner. You may know that capital gains are taxed at a lower rate, meaning there are tax benefits to earning capital gains.

One way to do that is by investing in companies that pay qualified dividends. It is important to understand that ordinary dividends are taxed as ordinary income. To reap the tax advantages of dividend income, you will need to invest in companies that pay qualified dividends, which must be issued by a United States company or a qualifying foreign company. You can find information about which companies are not considered to be qualified on page 20 of IRS Publication 550

If you have previously invested in companies that pay dividends, those dividends will be reported to you on Form 1099-DIV. Qualified dividend payments appear in Box 1b. Ordinary dividends appear in Box 1a. The maximum federal tax rate for qualified dividends is 20%.

8. Tax Residency Planning

One tax planning strategy to consider if you own properties in multiple states is tax residency planning. This strategy requires careful planning and attention to detail and is best done with an experienced tax accountant.

Income tax rates vary from state to state. Some states have high rates, while others have no state income tax. The states with no state income tax include:

• Alaska
• Florida
• Nevada
• New Hampshire
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming

If you own property in one of these states, consider establishing your primary residence there. However, be aware that some states aggressively pursue high earners if they earn money in the state or try to work around paying income taxes. You should also be aware that some states with low or no income tax charge higher rates for other things. Working with a professional accountant to determine individual state residency requirements will help you decide if this is the right strategy for you.

9. Pay Your Property Taxes Early

As of this post, IRS rules limit the property tax deduction to $10,000 per year thanks to the Tax Cuts and Jobs Act of 2017.

It may be worthwhile to pay taxes early if you haven't already reached the maximum. Some states and counties offer discounts for paying early, so you can also save money on the front end.

The most important thing to know is that the tax debt must be paid for you to deduct it from your federal taxes. You should consult an accountant to determine whether this option is an effective tax strategy for you.

10. Fund 529 Plans for Your Children

Paying for college is a significant expense, even if you’re a high-earner. One of the best ways for high earners to reduce their taxable income is by funding 529 college savings accounts for each child. A 529 is a tax-advantaged savings account. You can’t deduct contributions at the federal level, but some states allow you to do so. The money you contribute will grow on a tax-deferred basis, and withdrawals you use for eligible educational expenses are tax-free.

Contributing to a 529 won’t directly reduce your taxable income, but it is extremely useful for estate tax liability because you can contribute up to five times the annual exclusion for gifts at one time and thus remove those contributions from your estate.

11. Invest in an Opportunity Zone

If you have capital gains and want to reduce your tax burden for those gains, investing in an Opportunity Zone (OZ) can help you defer tax payments. Opportunity Zones were created as part of the Tax Cuts and Jobs Act of 2017.

According to the IRS, the purpose of Opportunity Zones is to “spur economic growth and job creation in low-income communities while providing tax benefits to investors.”

If you invest your capital gains in an Opportunity Zone, you can defer your capital gains tax payment until your investment in the OZ is sold or December 31, 2025, whichever comes first.

How President Biden's Proposed Tax Plan Would Affect High Earners

Many of the tax changes that were part of President Joe Biden’s original Build Back Better plan were eliminated in negotiations for the Inflation Reduction Act, which he signed into law in August of 2022.

The proposed changes, which are still floating around Congress, included the following:

• A 5% tax surcharge on taxpayers with a modified adjusted gross income of between $10 million and $25 million.
• An additional 3% surcharge on taxpayers with modified adjusted gross income over $25 million.
• A top capital gains tax rate increase from 20% to 28%, leaving the 3.8% net investment income tax in place.
• Biden's plan expands IRS enforcement by providing the budget to hire additional investigators to pursue top earners who evade taxes.
• The 3.8% Medicare surcharge would be applied to all pass-through businesses.
• The plan also minimizes deductions for business losses, although the specifics are not available as of this post.

If you want to save on taxes, there are several things you should know. The pass-through deduction is one option that can help with this.

We anticipate that any changes to the tax code between now and the 2024 presidential election will be minimal, with the Republicans in control of the House and Democrats retaining control of the Senate. We will update this post if any new changes are enacted.

Reduce High-Income Earners' Taxable Income with Smart Tax Planning

Being a high earner doesn't necessarily mean that you can't save money on your income taxes. The 11 strategies we have outlined here can help you find ways to reduce your tax bill.

The best way to identify tax incentives and strategies is to work with a CPA who understands the tax code and all its implications. Need help determining the best tax reduction strategies to lower your tax bill?