This post was originally published on December 17, 2021, and extensively updated
February 12, 2024
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:
Or you may be wondering...
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.
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.
Specifically, the RMD age increased to 73 for individuals who turned 72 after Dec. 31, 2022, or who will turn 72 before Jan. 1, 2033. It will increase to 75 for individuals turning 74 after Dec. 31, 2033.
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.
For 2024, there are seven income tax brackets. Here’s how they break down.
|
Bracket 1 |
Single |
Married Filing Separately |
Married Filing Jointly |
Single Head of Household |
|
Not over $11,600; 10% of taxable income |
Not over $11,600; 10% of taxable income |
Not over $23,200; 10% of taxable income |
Not over $16,550; 10% of taxable income |
|
|
Bracket 2 |
$11,601-$47,150; add 12% of amount over $11,601 |
$11,601-$47,150; add 12% of amount over $11,601 |
$23,201-$94,300; add 12% of amount over $23,201 |
$16,551-$63,100; add 12% of amount over $16,551 |
|
Bracket 3 |
$47,151-$100,525; add 22% of amount over $47,151 |
$47,151-$100,525; add 22% of amount over $47,151 |
$93,301-$201,050; add 22% of amount over $93,301 |
$63,101-100,500; add 22% of amount over $63,101 |
|
Bracket 4 |
$100,526-$191,950; add 24% of amount over $100,526 |
$100,526-$191,950; add 24% of amount over $100,526 |
$201,051-$383,900; add 24% of amount over $201,051 |
$100,501-$91,150; add 24% of amount over $100,501 |
|
Bracket 5 |
$191,951-$243,725; add 32% of amount over $191,951 |
$191,951-$243,725; add 32% of amount over $191,951 |
$383,901-$487,450; add 32% of amount over $383,901 |
$191,951 -$223,700; add 32% of amount over $191,951 |
|
Bracket 6 |
$243,726-$609,350; add 34% of amount over $243,726 |
$243,726-$609,350; add 34% of amount over $243,726 |
$487,451-$647,850; add 34% of amount over $431,900 |
$234,701-$539,900; add 34% of amount over $324,701 |
|
Bracket 7 |
Over $609,350; add 37% of amount over $609,350 |
Over $609,350; add 37% of amount over $609,350 |
Over $731,200; add 37% of amount over $731,200 |
Over $609,350; add 37% of amount over $609,350 |
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 $191,951 of taxable income as a single person, a married person filing separately, or a single head of household, or more than $383,901 of taxable income as a married person filing jointly, you are considered a high-income earner for tax purposes.
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 lower your tax bill.
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 lower your tax bill.
Let’s start with retirement accounts. Employer-based accounts such as 401(k) and 403(b) plans 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’ll 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 2024, the maximum 401(k) contribution and 403(b) contribution is $23,000, while the maximum contribution for SIMPLE IRAs is $16,000. Keep in mind that if you are over the age of 50, you may take advantage of catch-up contributions of up to $3,500 for SIMPLE IRA plans and $7,500 for 401(k)s.
Roth IRAs are tax-free retirement accounts that can help you reduce your tax burden and save money on your taxes, even if you’re in one of the top brackets. Unlike a traditional IRA, Roth IRA contributions are made from post-tax income. That means you’ll 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’ve 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 73 to make Required Minimum Distributions (RMDs). We like to suggest this option to our clients because it’s easy to overlook, especially when people are focused on tax deductions as a way of reducing their taxable income.
Municipal bonds might not be the most glamorous investment but can be a good option for high-income earners. 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 typically 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.
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’s 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’ll have a stepped-up tax basis of $900,000. You could sell it soon after inheriting the home and pay little to no capital gains tax. 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).
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’s a clever way to use charitable deductions to your advantage.
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 2024, the maximum contributions are:
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.
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 and a 20% penalty 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.
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’re 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’s important to understand that ordinary dividends are taxed as ordinary income. To reap the tax advantages of dividend income, you’ll 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%.
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:
If you own property in one of these states, you may 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. For example, California is considering a new wealth tax that would permit the state to tax assets even after residents move out of state.
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.
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.
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.
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, 2026, whichever comes first.