9 Ways for High Earners to Reduce Taxable Income [2022]

December 17, 2021 By Richard Poulson

This post was originally published May 27, 2020, and extensively updated
December 17, 2021.

When you earn a high income, you tend to pay a higher percentage of taxes than average earners. There are exceptions, of course, but in general, people who earn more pay more. And, 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 discussing and working on proactive tax planning with our clients, including those who have sizable incomes. In fact, one of the most common questions we hear is this:

What’s the best way to reduce taxable income?

9 Ways for High Earners to Reduce Taxable Income - 1

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.

Here are some of our favorite income tax reduction strategies for high earners.

Overview of Tax Rules for High-Income Earners

Let's start with an overview of tax rules for high-income earners. For the sake of this post, we consider anybody in the top three tax brackets as a high-income earner. That means that if you earn more than $170,050 in gross income as a single earner and $340,100 if you are married and filing jointly, you are a high-income earner. 

The SECURE Act, which became law at the end of 2019, includes several provisions that apply to high-income earners. They include:

  • The age for Required Minimum Distributions (RMDs) from retirement plan accounts was raised 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 remains at $6,000 per year.
  • 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 filing jointly).
  • Increasing limits for long-term care premium deductions to $5,640 per person for people age 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.

tax strategies for high income earners

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. Also, 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 9 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 would have 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 2020, the maximum 401(k) contribution is $20,500 and the maximum 403(b) contribution is the same, 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 Simple 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 the 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.

Learn More About 8 Ways to Minimize Capital Gains Tax Liability

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 of $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 that 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.

If you're considering making a crypto donation this year, you should read our blog post: Tax Implications of Crypto Donation to Charity.

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.

Hardworking small business owners may face the inevitable challenges of a tough economy. Preparing your small business for inflation is essential to maintaining your competitive edge in a fickle market. Check out our blog post: How Small Businesses Can Cope with the Impact of Inflation (9 Expert-Backed Strategies) for tips on protecting your small business from inflation and ensuring it remains profitable.

You can use the money in your HSA for medical and dental expenses as well as 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.

HSAs can help you with healthcare needs and save for retirement at the same time. They also provide tax benefits that make them a worthwhile investment. Check out our blog post: Using HSA Triple Tax Advantage To Save On Your Taxes.

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 that 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 will 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 is a strategy that 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 at all. These states include:

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

If you own property in one of these states, you may want to consider establishing your primary residence there. However, you should 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 writing, IRS rules limit the property tax deduction to $10,000 per year thanks to the Tax Cuts and Jobs Act of 2017. There was an attempt to repeal the limit in 2019, but it failed. That means the maximum you can deduct for state and local property taxes in any one tax year is $10,000.

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 save money on the front end as well.

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 with an accountant to determine whether this option is an effective tax strategy for you as a high earner.

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

In late October of 2021, President Joe Biden submitted a $1.75 trillion social and climate spending plan that would get most of its funding -- approximately $1 trillion from taxing the wealthiest Americans. Here are some of the key points that apply to high earners:

  • The plan does not officially alter the existing federal tax brackets.
  • The plan includes a 5% tax surcharge on taxpayers with a modified adjusted gross income of between $10 million and $25 million.
  • There is an additional 3% surcharge on taxpayers with modified adjusted gross income over $25 million.
  • The top capital gains tax rate will 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 writing.

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

From these provisions, the Biden Administration plans to finance its spending by taxing the wealthiest Americans. While it remains to be seen whether Biden has the votes to enact his plan, it is still necessary for high earners to take steps immediately to minimize their income tax burden before the new rules go into effect.

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 9 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?

Let's Talk: Schedule Your Free Consultation Right Now.

As a high earner, you may dabble in nontraditional investment methods such as cryptocurrency. If so, be sure to check out our post:


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