Tax Planning Strategies for High Income Earners

If you are lucky enough to be classified as a high income earner, great! I work with many clients who are classified as HENRY's (High earners, not rich yet). This describes families that make between $250k to $500k per year. Most of their future wealth is generated from their high income, rather than income generating assets. If they stop working, they will essentially be poor. These high earners often sacrifice their ability to accumulate wealth by living the expensive lifestyle that is expected of them. Often, they don't quality for many of the well known tax breaks because their income is too high. These taxpayers cringe when thinking about how much they are paying in taxes. If this sounds like you, thankfully, there are a few strategies that can be put into place to help ease your tax burden and get you on your way to saving more!

Take advantage of Retirement Accounts                                                                                                                                       

401k

Maxing out your 401k  is a must as a high income earner. It is an easy way to shelter $19k (as of 2019) of your income from taxes. Also, you can roll a 401k into an IRA and there are certain exceptions for withdrawal without penalty. This includes withdrawing money for a first home, paying for higher education expenses for yourself, spouse, child ,or grandchild, or for unreimbursed medical expenses. 

457B                                                                                                                         

If your job offers a 457B, even better! These account are not subject to early withdrawal penalties so if you retire early or simply leave the employer, all you have to pay is the tax and there is no penalty.  Some positions offer both a 401k and 457b plan which essentially allows you to put away $38k per year tax free. Take advantage if this is you! 

Solo 401k                                                                                                                                                                                              

 If you are self employed, have a side hustle, are an independent contractor, and don't have employees, this plan is for you. If you don't have a 401k at work you can put away the max employee contribution of $19k. Even if you do have a 401k through work that you max out,  you can still make the plans profit sharing contribution of 25% of compensation. The overall contribution limit for the solo 401k is $56k. Not bad. 

Defined Benefit Plan                                                                                                                                                                               

If you are the owner of a highly profitable business and don't mind paying a couple thousand every year to maintain this plan, you will be able to put away quite a bit of money into a defined benefit plan. The contribution limit for 2019 is $225k. That is $225k that you will not have to pay tax on! If you are in this situation make sure you are aware of this option and how it works.                                  

Become and Independent Contractor or Start a Side Business                                                                      

Let's face it, business owners get all of the deductions when it comes to taxes. The new TCJA (Tax Cut and Jobs Act) eliminates most of the deductions that were previously available to W-2 employees, but business owners can still enjoy all of them. Section 199A  allows a special 20% QBI deduction for  small businesses pass-through entities. This includes sole-proprietorships,  LLCs, Partnerships and S Corps.  If you can change your status from employee to independent contractor you may be able to save thousands on your tax bill. Even if that isn't possible you can still generate some side business income and deduct your expenses related to the business. This could include a home office deduction, business related travel, etc. Not to mention all the additional tax free money you can put away for retirement (see above). Getting in the self employed game could save you some serious tax dollars.

Invest in Real Estate

Real estate investments are truly special because of an on paper deduction that you don't actually have to "spend" to get. Thats right, depreciation! When you buy rental real estate, you are allowed to deduct the cost of the building over 27.5 years. For example, if you buy a rental property for $350k and you attribute $75k to the land and $275k to the building, you can deduct $10k per year in depreciation  for the building from your taxes each year. Let say  you have $2k in mortgage interest related to the rental and are charging $1k a month ($12k per year). In this scenerio, you will have 0 income to claim even though your cash profit is  around $10k. Do this over and over and you can really get ahead on taxes.

Tax Loss Harvesting                                                                                                                                                                            

If you have an investment that has lost money, you can sell it and realize that loss.  By selling your losers, you are creating a taxable loss. This can help reduce your tax bill either by offsetting gains or taking a deduction (subject to limitations) for your losses. It’s a good idea to get back in the game so you are still invested in the market and be able to participate in any future market recovery . "Wash-sale” rules prevent you from buying the exact same or substantially identical investment  for 30 days, but you can always purchase a mutual fund  or a different type of security in the same industry to take advantage of gains in the future.

Donor Advised Funds for Charitable Donations                                                                                                             

Setting up a donor advised fund at an investment custodian such as T.D. or Fidelity can provide you with a deduction now for funds you can donate to the charity of your choice later.  For example, lets say you contribute $25k  to a donor advised fund in 2019, you will receive the full $25k in tax deductions for that year. The donation will be invested and any growth or income will be tax-free. When you are ready, you can grant the money to the charity of your choosing as you see fit. This is a great way to make charitable donations and receive the tax deduction in years that your income is high.  

If you want to implement any of these strategies or need tax help in general, send me a message on my contact page so we can get started!

Alicia Jegede is the principal CPA and financial planner at New Gen Financial Planning, LLC. 

Disclaimer: This article is provided for general information purposes only. Nothing contained in the material constitutes advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Alicia Jegede.  All rights reserved.