The Internal Revenue Service (IRS) tax code is full of legal ways for high-income Americans to pay less in taxes. Taking a proactive tax-planning approach can help you minimize your taxes both today and in the future.
During my nearly 20 years as a West Hollywood financial planner, I often am hired to help people stay on track for their most important financial goals like a secure retirement, achieving financial freedom, or perhaps, purchasing a second home in a fabulous place like Palm Springs or Puerto Vallarta. Earning your income in a more tax-efficient way can make that process easier. Tax planning is a significant portion of every financial roadmap I put together for my clients. As I always say, it’s not what you make but what you keep.
Maximize The Tax Advantages of Retirement Accounts
Making the maximum contributions each year to your retirement account is one of the most common ways to minimize your taxes each year.
For the highest income-earning folks reading this, you will likely need to invest well beyond basic IRA or 401(k) limits to truly make a dent in your tax bills or stay on track for a fully funded and secure retirement for that matter.
For high-income-earning business owners, as your income grows, the number of tax deductions you will need to keep your tax bill in check will also increase. Luckily, you can potentially set up a 401(k) profit-sharing plan and contribute $61,000 per year (as employee and employer combined). That alone may be reason enough to hire your spouse. Pre-tax double contributions to this type of plan will make a big dent in your tax bills.
Once you have contributed the maximum amount allowed to your 401(k), you may want to consider what I call the Rich Person Pension or Cash Balance Pension Plan or Defined-Benefit Pension Plan as they’re more commonly called. These types of plans have been growing in popularity over the past few years, but interest has skyrocketed since the Trump Tax Plan, which started in 2018. You can potentially sock away a few hundred thousand dollars each year, pre-tax! For business owners in California, the tax saving could be more than 50%.
Don’t Forget to Capitalize on Depreciation
Here is a quick description of what is considered depreciation from the IRS website.
“Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property. It is an annual allowance for the wear and tear, deterioration, or obsolescence of the property.
Most types of tangible property used for your business (except land), such as buildings, machinery, vehicles, furniture, and equipment, may bring tax benefits from depreciation. Likewise, certain intangible property, such as patents, copyrights, and computer software, is depreciable.”
They are Self-Employed and Maximize Tax Deductions
There are many more tax-planning strategies available for the self-employed or business owners. While not very sexy, ensuring your business has good bookkeeping can help you lower your tax bill each year. If you forget about a tax-deductible expense, you are likely overpaying your taxes. Staying current with bookkeeping will help you avoid missing valuable tax deductions for your business. This is even more imperative now with the new Qualified Business Income (QBI) pass-through deductions for small business owners.
They Donate Appreciated Stock to Charity
Why donate cash when you can donate highly appreciated stocks? You get a tax deduction for the full current value of the stock but avoid having to pay capital gains to convert the stock into cash to donate. Yes, you have to give money to charity, but I hope this is something you are doing each year regardless of the tax benefits.
Health Insurance Is Tax Deductible When Self-Employed
Insurance is typically cheaper when you have an employer to help shoulder most of the cost. However, when you are the business owner paying the full premium, you get a tax break for your full premiums. At the same time, medical expenses are only tax-deductible when they exceed 7.5% of your income. So, unless you have a really low income or major health issues, most workers won’t be able to deduct their medical expenses. With this in mind, it may make sense for a business owner to pay for top-of-the-line health insurance, ensuring a larger tax deduction and lower out-of-pocket costs at the end of the day.
They Use Life Insurance Like a Rich Person Roth
When structured properly, life insurance can provide tax-free growth and tax-free income. The Rich Person Roth doesn’t come with those pesky income limits and small contribution limits that minimize the value of a regular Roth IRA. This strategy to maximize tax-free income is best for those who have already maxed out their other tax-favored retirement accounts.
If you are being pitched a huge permanent life policy, and you aren’t in a high tax bracket and haven’t maxed out your other retirement accounts, someone is likely trying to make a huge commission at your expense and is not acting in a fiduciary capacity.
Don’t let these six valuable tax-saving strategies overwhelm you. You don’t need to implement all of these strategies today, or ever for that matter. What is important is that you are aware that there are other tax-saving strategies out there that you might need at some point. As your income grows (or perhaps tax laws change), you may need to put a little more effort into your tax planning to help keep more of your hard-earned money. Keep growing your business and have a great fiduciary financial planner, who also offers tax-planning guidance, and a CPA nearby to keep your taxes from gobbling up your increases in income.