Reducing your taxes as a high-income earner is critical to build lasting wealth.
When you earn more income, you are subject to more taxes. And watching a significant chunk of your hard-earned income go to taxes can be disheartening.
Fortunately, there are several ways to reduce your tax burden by using the tax saving strategies covered in this post.
You will learn that you can reduce your taxes by carefully structuring how you invest, spend, move, or give money. There are various tax breaks, deductions, and credits available based on the decisions you make.
Keep reading to learn the most valuable ways to reduce your taxes as a high-income individual.
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What is Considered a High Income?
The IRS defines a high-income earner as anyone who reports $200,000 or more in total income on their tax return.
Total income is the sum of all the amounts shown from different income sources on an individual’s tax return.
How To Reduce Taxes As A High-Income Earner
When you earn high-income, there are multiple ways to reduce the amount of taxes you pay.
You can implement some of these strategies yourself, while others may require a Tax CPA.
Nonetheless, these are some of the best ways to reduce taxes for high-income earners:
1. Maximize Retirement Contributions
Putting money into a traditional retirement account reduces the amount of income that is subject to taxes.
This is because the money you contribute can be deducted from your total income. You receive a dollar-for-dollar tax deduction for each dollar you contribute to a traditional retirement plan.
Thus, allowing you to pay less tax on the remaining income.
For example, someone with $200,000 in income who contributes $20,000 to a Traditional 401K would only report $180,000 in taxable income.
Therefore, making pre-tax contributions to Traditional 401(k) plans and IRAs can save high-income individuals a lot of money on taxes.
In 2024, high-income earners can contribute up to:
- $23,000 to a Traditional 401K as an employee (or $30,500 if over 50 years of age)
- $46,000 to a Solo 401K or SEP IRA as an employer (or $53,500 if over 50 years of age)
- $7,000 to a Traditional IRA (or $8,000 if over 50 years of age)
With either plan, there are income limits that may impact your ability to maximize your deductions. Be sure to review this in detail or consult a CPA.
2. Contribute to a Health Savings Account
You receive a tax deduction for each dollar you put into a Health Savings Account (HSA), up to a certain limit.
For 2024, the maximum amounts you can contribute are:
- $4,150 for individuals
- $8,300 for families
If you are 55 or older, you can contribute an extra $1,000. The limits on HSA contributions go up with inflation each year, even though medical costs usually increase faster than inflation.
You can use the money in your HSA to pay for qualified health expenses such as medical and dental expenses, as well as things like over-the-counter medications and first aid supplies.
And when you use your HSA for qualified health expenses, the money comes out tax-free. Therefore, you will never pay tax on income you move to your HSA.
However, you must have a high-deductible health insurance plan in order to qualify for a health savings account.
3. Use Deferred Compensation Plan
Deferred compensation plans allow you to delay receiving a portion of your income until retirement.
By delaying your income, you are able to report less taxable income on your tax return. This can be incredibly beneficial when you are in a very high tax bracket.
You can essentially defer income to the future when you may be in a lower bracket.
These plans provide some key benefits for high-income individuals:
- Reduce current year tax burden when deferring income
- Potentially pay less in taxes overall by withdrawing in lower tax brackets
- Flexibility to receive money as lump sum or annuity stream
- Potential to avoid high state taxes if retiring to a low-tax state
- Enable saving beyond annual retirement contribution limits
However, careful planning is critical, as deferred compensation is very difficult to reverse once elected. And there are risks – if your company goes bankrupt, you could lose all deferred income.
Who Can Participate in a Deferred Compensation Plan?
Only individuals performing services for the eligible employer, whether as employees or independent contractors, are allowed to participate.
4. Maximize Individual Deductions
For high-income earners, strategically maximizing tax deductions is necessary for reducing a substantial tax burden.
One key area to focus on is deciding whether to take the standard deduction or itemize individual deductions.
While most taxpayers take the standard deduction, high-income earners are more likely to benefit from the itemized deduction based on the circumstances.
Itemized deductions can add up to be more than the standard deduction, especially if you own a home, have significant medical expenses, or make large charitable donations. The higher these deductions are, the lower your taxable income will be under the itemized deduction.
The itemized deductions allows you to write-off:
- Medical and dental expenses that exceed 7.5% of your income
- State and local taxes up to $10,000
- Mortgage interest expenses
- Gifts to Charity
- Casualty and Theft Losses
To maximize your individual tax deductions, you should choose the deduction that provides you the highest tax deduction.
Generally, itemizing only makes sense if those total deductions are higher than the standard amount you qualify for based on your filing status. A good tax planner will be able to calculate your tax savings from both and tell you which one is most beneficial.
5. Create Large Charitable Contributions
For high-income earners looking to maximize tax deductions, creating large charitable contributions can be an extremely effective strategy.
Charitable donations is an itemized tax deduction. However, high-income earners may be able to increase their charitable donations with donor advised funds or private foundations.
The following methods allow high-income earners to put aside money to fund future charitable giving, while receiving an upfront tax deduction for it.
Donor Advised Funds
A donor-advised fund allows you to create a large, upfront charitable tax deduction in one given year.
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Technically, a donor-advised fund is a charity giving vehicle administered by a public charity. As the donor, you can advise the charity on how you’d like the funds to be distributed and can choose the charities you’d like it to be distributed to.
Essentially, the fund acts as charitable savings account for charitable giving. When you put money to it, it is considered a charitable donation.
Therefore, a high-income earner that already gives to charity each year may benefit from a donor advised fund.
It allows them to trigger a larger tax charitable tax deduction for funds they already planned to give to charities in future tax years. The donor advised fund allows them to claim those charitable donations upfront.
For example, someone who gives $10,000 to charities each year would only receive a $10,000 charitable donation.
However, if they decide to put $100,000 in a donor advised fund they would create a $100,000 charitable deduction.
Then, they can use their donor advised fund to give the same $10,000 to charities of their choice, each year. The only difference is that they recognized the tax deduction sooner.
Additionally, the donated money that goes into the fund you can be invested and grown tax-free.
The IRS allows you to deduct cash donations of up to 60% of your adjusted gross income from your taxes. Therefore, individuals considering this strategy should be mindful of their respective donation limit.
Private Foundations
For high-income individuals, creating a private family foundation is another way to maximize charitable deductions.
A private foundation is a 501(c)(3) organization that can make grants to charities. Because it is a nonprofit, you receive a tax deduction for every dollar you give to the foundation.
Then, you can choose to give to charities over several years or decades from your foundation.
The tax benefits are similar to a donor advised fund, except you more control with a private foundation.
Additionally, you can involve your family with your private foundation and deduct certain expenses related to maintaining the foundation.
No matter which route you choose, making substantial upfront charitable contributions can yield massive deductions that significantly reduce taxable income for high earners in the short term.
6. Leverage Business Write-offs
If you’re a high-income earner searching for ways to lower your taxes, leveraging business write-offs could be a big help.
This is because there are over 100 additional tax write-offs available for business owners. To qualify, you simply need to earn non-employment income, such as 1099 income or business income.
Many high-income individuals are able to take advantage of these write-offs through a side gig or small business.
These deductions, which are designed to offset the costs of doing business, can significantly reduce taxable income, making them especially beneficial for those in higher tax brackets.
Under Section 162 of the IRS Tax Code, ordinary and necessary business expenses are eligible for deductions.
The following are some of the best business write-offs for high-income earners:
- Home Office: Deducting home office expenses is a great way to reduce taxable income if you use a part of your home exclusively for business activities. This includes a portion of utilities, home insurance, mortgage interest or rent, and depreciation.
- Business Travel: All expenses related to business travel, including airfare, hotel stays, and meals, can be deducted, provided they are necessary to the business and properly documented.
- Business Meals: Meeting clients over meals or catering during business meetings offers a deductible expense, with limitations and conditions as per IRS guidelines.
- Car Expenses: Using a personal vehicle for business purposes allows you to deduct costs such as maintenance, fuel, and insurance, or simply use the IRS’s standard mileage rate.
- Health Insurance: Self-employed individuals can deduct premiums paid for health, dental, and qualifying long-term care insurance for themselves and their dependents.
To learn the best small business tax deductions, be sure to read our post, 34 Big Small Business Tax Deductions.
7. Create Real Estate “Paper” Losses
High-income individuals can invest in real estate to significantly reduce their taxes.
Many real estate investors strategically utilize “paper” losses to effectively reduce their tax liabilities. These losses, predominantly arising from rental property investments, are primarily derived from depreciation deductions.
Depreciation is a non-cash deduction that accounts for the perceived decrease in the value of real estate over time due to wear and tear.
This deduction enables investors to report a taxable loss on their property, which does not impact their actual cash flow.
Even when rental properties are operating profitably and appreciating in value, depreciation may be claimed to reduce profits and taxes.
Depreciation may reduce all taxable income from rental investments, and can even offset income earned from other sources, such as wages or business income. These offsets effectively reduces the overall tax burden.
There are even ways to “accelerate” the rate of depreciation taken with a cost segregation study, sometimes allowing investors to write-off 20-30% of their properties’ values in one year.
By default, the IRS allows you to write-off a portion of your property’s value over 27.5 years if it is a residential property, or 39 years if it is a commercial property.
However, a cost segregation study allows you take advantage of components of your properties with shorter useful lives, thereby increasing your depreciation deduction.
8. Avoid Selling Your Investments
As a high-income earner, you can reduce your taxes by avoiding events that trigger tax in the first place.
You do not pay tax when your investments rise in value, or appreciate. You create a taxable event when you sell an investment for a gain. Therefore, if you do not sell your investments, you will not trigger taxes.
To accomplish this, consider long-term investments that appreciate in value and requires minimal trading. This will allow you to benefit from the appreciation of your assets while minimizing the amount of taxes you pay along the way.
However, in some cases this may not be possible. In the event that you absolutely need to sell your investments, then try to sell what you absolutely need or have a plan for.
9. Borrow Against Your Investments
One way to reduce your investment tax is to borrow against your investments, as opposed to selling them.
When you borrow money, the proceeds are not subject to tax. When you sell investments, the proceeds are subject to tax. Therefore, you can reduce your taxes by borrowing against your investment assets.
It provides you with the following benefits:
- Access to cash that is not subject to taxes
- Ability to keep your assets invested for higher growth
- Ability to invest the loan proceeds into more wealth-building assets
- Ability to write-off the interest expense as a tax deduction
This strategy is particularly popular amongst the wealthy. Billionaires like Jeff Bezos and Elon Musk use this strategy effectively, often resulting in surprisingly low tax rates.
Though, while it might seem like a tactic only accessible to the very wealthy, the underlying principles can be adapted by individuals at various wealth levels.
Anyone with investment assets may be able to use this strategy. Below are some common ways to borrow against your assets:
- Securities-Backed Line of Credit: Used to borrow against assets in your brokerage account, such as stocks, bonds, and money market funds
- Portfolio Line of Credit: Used to borrow against assets in your portfolio
- Home Equity Line of Credit: Used to borrow against your equity in real estate properties
- Business Line of Credit: Used to borrow against your equity in a business venture
- Secured Loan: Used to borrow against any asset used as collateral
High-income individuals considering this strategy will need to weigh the risk/reward of bearing interest expense and the risk of having to repay the loan if their assets decline in value.
10. Sell for Long-term Capital Gains
When seeking to reduce taxes, high-income individuals should also optimize their investments for the lowest possible tax rate.
Typically, your investment gains are taxed as a “short-term capital gain” or “long-term capital gain”.
The type of capital gains tax you pay will depend on how long you held the asset before selling it.
If you held an asset for over a year before selling, you qualify for the lower long-term capital gains tax rates.
But if you sold an asset you owned for a year or less, those are short-term capital gains taxed at your regular higher income tax rate (with a few exceptions to the one-year rule).
The U.S. tax system favors long-term investing over short-term. Short-term investment gains are taxed higher than long-term gains.
Short-term vs. Long-term capital gains rates
Short-term gains are treated as regular taxable income, subject to higher rates ranging from 10-37% of your income.
Long-term gains are taxed at reduced rates (0-20%), providing a tax advantage to those who invest with a long-term perspective.
By strategically planning the duration of your investments, you can significantly reduce the amount of tax you pay on investment gains.
This approach not only aligns with U.S. tax laws that favor long-term investing but also maximizes your potential financial returns.
11. Time Your Capital Gains for the Lowest Rate
Timing capital gains to align with the lowest tax rate is a strategic move that can significantly reduce the tax burden for high-income earners.
This involves carefully planning the sale of assets like stocks, bonds, or real estate to coincide with years when your income—and consequently your tax rate—is lower.
For high-income earners, marginal tax rates can vary significantly from year to year based on overall income levels, changes in tax laws, or other financial changes.
By waiting to sell an asset during a year when you expect to have a lower income, you can take advantage of lower capital gains tax rates.
This timing allows you to maximize your profits from the sale by minimizing the taxes owed.
12. Create a Roth Retirement Account
Certain high-income individuals may reduce taxes on their investments by using a Roth investment account, such as a Roth IRA or Roth 401K.
Roths can help high-income earners in a few ways:
- Tax-free growth: Money in a Roth grows tax-free, so high earners don’t pay taxes on withdrawals in retirement.
- No required withdrawals: There’s no requirement to take money out of a Roth during your lifetime, unlike traditional retirement accounts.
- Tax diversification: it provides a tax-efficient source to pull money from in the future. You can use a mix of roth, traditional, and taxable accounts to provide more flexibility and control over your investments in the future
Unlike a Traditional IRA, you pay taxes upfront on the money you contribute to a Roth IRA. But then the money grows tax-free, and you don’t pay taxes when you take it out in retirement.
Because you pay taxes upfront with a Roth, we find that it is most beneficial when you are lower tax bracket.
We generally recommend Roth when a taxpayer’s tax bracket is below 20-30%. Beyond this range, a Traditional IRA is typically more beneficial.
In addition to this, there are income limits that may impact the eligibility of a high-income taxpayer using the Roth.
However, there are various strategies used to get around those limits, such as the “Backdoor Roth” or “Mega Backdoor Roth”.
12. Setup 529 Plans
A 529 College Savings Plan is an excellent way for high-income earners to minimize their taxes.
These plans are set up to support future educational costs, from college to other post-secondary training.
Similar to a Roth, a 529 Plan is funded with aftertax dollars and the investment earnings are tax-free if withdrawn for eligible expenses.
Earnings are not subject to federal tax when used for eligible college expenses and are not often subject to state tax.
Withdrawals used for eligible educational expenses are tax-free, and contributions grow tax-deferred.
Plus, there’s flexibility: contributions are only limited by the qualified education expenses of the beneficiary and you can switch who benefits from the fund within the family.
It’s an effective way to save for future education expenses while enjoying tax advantages.
13. Use Cash Value Life Insurance
High-income earners commonly use cash-value life insurance policies to minimize their tax burden while securing their financial stability.
This type of life insurance policy not only provides death benefits but also accumulates a cash value over time, which policyholders can use under favorable tax conditions.
How High-Income Earners Can Use this to Their Advantage:
- Tax-Deferred Growth:
The cash value in these life insurance policies grows tax-deferred, meaning you won’t pay taxes on the growth each year.
This allows the cash value to increase more rapidly than it might in a taxable account, where annual taxes could diminish returns.
- Tax-Free Withdrawals Up to Premium Paid:
You can make withdrawals from the cash value of your policy tax-free, up to the amount of premiums you have paid. This is particularly advantageous for high-income earners, as it provides a source of funds that doesn’t increase their taxable income for the year.
- Policy Loans:
Borrowing against the cash value of your life insurance policy is another tax-efficient strategy.
Loans taken out against the cash value are not taxable events, even if they exceed the premiums.
It’s important to keep the policy active and not let it lapse with an outstanding loan, as this could lead to a taxable event.
- Avoiding MEC Status:
To maintain the favorable tax treatment of a cash-value life insurance policy, ensure not to overfund the policy quickly. If contributions exceed certain limits, the policy may become a Modified Endowment Contract (MEC), which subjects withdrawals to less favorable tax treatment, where earnings are taxed first.
- Using Life Insurance in Estate Planning:
For high-income individuals concerned about estate taxes, cash-value life insurance can play a pivotal role.
Proceeds from life insurance policies are generally income tax-free for beneficiaries and can be structured to be estate tax-free. This makes them an excellent tool for wealth transfer.
Cash-value life insurance offers multiple avenues for tax savings and financial planning, making it a powerful component of a comprehensive strategy for high-income earners.
It is advisable to work with a tax professional to tailor these approaches to individual needs and maximize the financial benefits while adhering to tax regulations.
14. Buy municipal bonds
Municipal bonds are a type of investment where you lend money to a city or state government.
The interest you earn from these bonds is usually not taxed by the federal government or the state you live in.
Even though municipal bonds pay lower interest rates than some other investments, they can still be a good way for high-income earners to reduce their taxable income and earn some interest tax-free.
15. Buy treasury securities
For high-income earners seeking ways to optimize their tax liabilities while ensuring steady income, buying treasury securities offers a compelling solution.
These government-issued securities not only provide a safe investment vehicle but also come with unique tax advantages that can significantly benefit those in higher tax brackets.
Exemption from State and Local Taxes
One of the primary tax advantages of U.S. Treasury securities is that the interest income they generate is exempt from state and local taxes.
For high-income earners, particularly those residing in states with high tax rates, this exemption can result in substantial tax savings.
By avoiding state and local taxes on interest earned from these securities, investors can retain more of their investment income.
Federal Tax Considerations
While interest income from Treasury securities is subject to federal taxation, the ability to shield this income from state and local taxes makes them an attractive option.
The tax savings achieved at the state level can effectively lower the overall tax burden on investment income, making treasuries a wise choice for those looking to manage their federal tax liabilities more efficiently.
Favorable Tax Treatment with Specific Types of Treasury Securities
Zero-Coupon Bonds (e.g., STRIPS): These securities do not pay interest until maturity and are sold at a discount. For high-income earners, STRIPS can provide a way to defer taxes until the bonds mature, which can be strategically beneficial if timed with periods of lower income.
Treasury Inflation-Protected Securities (TIPS): The adjustments to the principal of TIPS for inflation are taxable as capital gains in the year they occur.
However, high-income earners can use decreases in TIPS principal (due to deflation) to offset other taxable income, providing another layer of tax planning strategy.
Strategic Timing for Interest Income
Investing in Treasury securities allows for the strategic timing of income recognition.
High-income earners can plan their investment and disinvestment in these securities around other income fluctuations to optimize their tax situation.
For instance, selling Treasury securities in a year when other income is lower can help manage marginal tax rates more effectively.
The Bottom Line for the Ways To Reduce Taxes for High-Income Earners
Now, there’s no need to feel disheartened when a significant portion of your hard-earned income goes towards taxes.
While it’s natural to want to keep more of your money, the good news is that there are plenty of practical and legal ways to reduce your tax burden as a high-income earner.
Remember, the goal isn’t to avoid paying taxes altogether – that’s simply not possible or advisable.
Instead, focus on making the most of the available tax breaks and deductions you’re entitled to claim.
One of the best ways to do that is by working closely with a qualified tax professional.
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