As a company founder, early startup employee, or small business owner, you may find yourself in a higher tax bracket as your business grows or you realize gains from equity compensation. But that doesn’t mean you simply have to accept a higher tax bill. With the right guidance, there are ways to reduce your federal taxes and your state and local taxes. In this article, we’ll explore 20 tax-saving strategies you can consider to reduce your taxable income.
Table of Contents
- Retirement contributions
- Charitable contributions
- State and Local Tax (SALT) deductions
- Qualified Small Business Stock (QSBS)
- 83(b) Elections
- Tax-loss harvesting
- Qualified Opportunity Zone investments
- Mortgage interest deductions
- Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs)
- Business and self-employment tax efficiencies
- Qualified medical expenses and healthcare costs
- Qualified education expenses
- Tax residency planning
- Tax-efficient investment strategies
- Roth conversions
- Real estate investing
- Deferred income
- Tax-efficient non-charitable giving
- Environmental tax breaks
- Tax-efficient estate planning
The definition of a high-income earner according to the IRS
The IRS definition of a high-income earner is not perfectly clear. Generally, two definitions are widely reported within the industry:
- The Tax Reform Act of 1976 mandates the annual reporting of data on individual income tax returns with income of $200,000 or more.
- Taxpayers who fall into the top 3 tax brackets which in the 2023 tax year is anyone with income of $182,101 or more.
Income can be from wages and salaries, investment income, business transactions, and more. It’s important to understand what is counted as income by the IRS so you know which tax bracket you fall in as your income increases. By working with a tax professional, you can apply tax strategies to reduce your taxable income or defer paying taxes.
20 tax reduction strategies for high-income earners in 2024
Tax strategy is complex, and there are numerous ways of reducing taxable income depending on your situation. Here are 20 tax-efficient actions to consider when filing your taxes in 2024.
1. Retirement contributions
Individuals can take advantage of various tax-related retirement planning strategies to reduce their taxable income today and post-retirement.
Traditional 401(k) and Roth 401(k)
A Traditional 401(k) allows employees to make pre-tax contributions from their salary, which can then grow tax-deferred until the funds are withdrawn later in retirement. This reduces an individual’s taxable income in the year they are made, which can be advantageous for individuals in higher tax brackets during their pre-retirement years.
A Roth 401(k) is funded with after-tax dollars, meaning the contributions are taxed before they are deposited into the account, but withdrawals during retirement are tax-free, including the earnings on the investment. This may be beneficial for taxpayers who anticipate being in a higher tax bracket in retirement or for those who prefer the certainty of tax-free income in their later years.
Traditional IRA and Roth IRA
A Traditional IRA allows individuals to make contributions that may be fully or partially deductible, depending on their income and participation in an employer-sponsored plan, with the investments growing tax-deferred until withdrawals begin. Contributions to a Traditional IRA reduce your taxable income in the year they are made, offering an immediate tax break.
In contrast, Roth IRAs are funded with after-tax dollars, meaning contributions are not tax-deductible, but qualified withdrawals, including earnings, are tax-free, provided certain conditions are met. Although contributions do not reduce current taxable income, tax-free withdrawals in retirement can benefit those who anticipate higher tax rates in the future or value financial flexibility in retirement.
Solo 401(k) and SEP-IRA
Solo 401(k) and SEP-IRA accounts are retirement savings options designed for self-employed individuals and small business owners, offering a way to save for retirement while taking advantage of tax benefits. For example, contributions to a Solo 401(k) can be made as the employee and the employer, which can greatly increase the contribution limit and thus the potential tax deduction. The contributions reduce taxable income, leading to immediate tax savings, and the earnings grow tax-deferred until withdrawal. Similarly, SEP-IRA contributions are tax-deductible for the business, reducing the business’s taxable income.
2. Charitable contributions
Leveraging the various ways to donate to charity can put your money to good use and help reduce taxes.
Donor-Advised Fund
A donor-advised fund (DAF) is a philanthropic account administered by a public charity that allows donors to make a charitable contribution and receive an immediate tax benefit. The donor may then recommend grants from the fund over time to their chosen charitable organizations. Donors who contribute to a DAF can deposit cash, securities, or other assets into the fund. The donor relinquishes ownership of the assets but retains advisory privileges over how the contributions are invested and how grants are distributed to charities.
Donations to a DAF are tax-deductible in the year they are made, which can help reduce the donor’s taxable income. Additionally, if the donation consists of appreciated securities or assets, the donor can avoid capital gains taxes that would otherwise arise from selling those assets.
Bunching Donations
“Bunching donations” is a strategic tax planning method that involves consolidating multiple years’ worth of charitable contributions into a single tax year. The primary benefit of bunching donations is that it allows taxpayers to maximize their deductions in a high-income year or when it is most advantageous from a tax perspective.
Donate stock or appreciated assets
When a donor contributes appreciated assets, such as stock or bonds, that they have held for more than one year to a qualified charitable organization or a donor-advised fund, they can avoid capital gains taxes that would otherwise be owed if the assets were sold.
Qualified Charitable Distributions
Qualified Charitable Distributions (QCDs) allow individuals 70½ and older to donate up to $100,000 directly from their Individual Retirement Accounts (IRAs) to a qualified charity without having to include the distribution in their taxable income.
Charitable Lead Trusts and Charitable Remainder Trusts
A Charitable Lead Trust is structured to provide a fixed annual payment to one or more charitable organizations for a set period of time, after which the remaining assets in the trust revert to the donor or other designated non-charitable beneficiaries. Depending on how the trust is structured, CLTs can result in income, gift, and estate tax deductions for the donor.
A Charitable Remainder Trust is designed to provide a stream of income to non-charitable beneficiaries for a set period or for the lifetimes of the beneficiaries, after which the remainder of the trust’s assets is donated to one or more charitable organizations. The donor receives an immediate tax deduction and often avoids the capital gains tax on the donated assets.
3. State and local tax (SALT) deductions
State and Local Tax (SALT) deductions allow taxpayers to deduct certain taxes paid to state and local governments from their federal taxable income. These taxes can include state and local property taxes, income taxes, and sales taxes. It’s important to note that the Tax Cuts and Jobs Act of 2017 introduced a cap on SALT deductions, limiting the total deductible amount to $10,000 ($5,000 for married taxpayers filing separately).
4. Qualified small business stock (QSBS)
Qualified Small Business Stock (QSBS) refers to shares in a corporation that meets certain criteria set by the Internal Revenue Code. If the stock is held for more than five years, the investor can exclude up to 100% of the capital gains from the sale of the QSBS from their income, subject to certain limits.
5. 83(b) Election
The 83(b) Election is a provision under Section 83(b) of the Internal Revenue Code that allows startup founders or employees who receive equity compensation to choose to pay taxes on the fair market value of their shares when granted instead of when they vest. This can provide tax benefits if you anticipate a significant increase in the value of your shares or startup as a whole, potentially resulting in tax savings if and when you sell your shares.
6. Tax-loss harvesting
Tax-loss harvesting is used to reduce taxes by selling investments that are at a loss and then using those losses to offset realized capital gains or up to $3,000 ($1,500 if married filing separately) of ordinary income per year. Excess losses can be carried forward to future years. Keep in mind that breaking the wash-sale rule. The rule states that the sale of a security followed by repurchasing a substantially identical security within 30 days before or after the sale disallows the tax deduction.
7. Qualified Opportunity Zone investments
Qualified Opportunity Zones (QOZs) are economically distressed communities designated for investment to spur economic growth. Investments in these zones are made through Qualified Opportunity Funds (QOFs). Tax benefits of these investments can include the deferral and reduction of capital gains taxes and the possible exemption of taxes on the QOF investment.
8. Deduct mortgage interest
The mortgage interest tax deduction allows homeowners to deduct the qualified interest paid on a mortgage for their primary residence and possibly a second home from their taxable income. Lenders report the amount of mortgage interest paid by the borrower in a given year on Form 1098, which is the Mortgage Interest Statement.
9. HSAs and FSAs
Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) are two types of tax-advantaged accounts that can be used to pay for eligible medical and other qualifying expenses.
Health Savings Accounts (HSAs)
HSAs are available to individuals enrolled in high-deductible health plans (HDHPs). HSAs offer what’s referred to as a “triple tax advantage” in that contributions are tax-free, investment earnings grow tax-free, and qualified distributions are tax-free. Contributions to an HSA are deposited with pre-tax dollars, reducing your taxable income in the year they are made. In 2024, the maximum HSA contribution for self-only coverage is $4,150 and $8,300 for families. The funds, which can be invested similarly to a retirement account, grow tax-free, and withdrawals for qualified medical expenses are also tax-free. Another advantage of HSAs is the funds carry over each year and do not count towards the new year’s maximum contribution, allowing HSAs to grow tax-free throughout your life.
Flexible Spending Accounts (FSAs)
FSAs are employer-sponsored accounts that allow employees to set aside pre-tax dollars for eligible medical (and sometimes dependent care) expenses. Contributions to an FSA reduce your taxable income, similar to HSAs. Withdrawals used for qualified expenses are tax-free. However, FSAs generally have a “use-it-or-lose-it” rule, meaning leftover funds are lost at the end of the year.
10. Business and self-employment tax efficiencies
Small businesses and self-employed individuals can take advantage of various tax deductions and efficiencies to reduce their taxable income.
Business expense deductions
These may include deductions for home office expenses, health insurance premiums, vehicle expenses, and contributions to self-employment retirement plans.
Qualified business income deduction
The Tax Cuts and Jobs Act (TCJA) of 2017 allowed for freelancers and small business owners to claim the Qualified Business Income (QBI) deduction. This tax deduction allows eligible self-employed individuals to deduct up to 20% of their qualified business income from their taxable income.
Business entity restructuring
Small businesses and self-employed individuals may decide to work with a tax advisor to select the most tax-efficient structure for their business, often selecting from an LLC, S-Corporation, or C-Corporation. Not only can the right business structure provide tax-efficiencies but it helps minimize personal legal liability creating clear boundaries between business entities and individual owners.
11. Qualified medical expenses and healthcare costs
If you itemize deductions on your tax return, you can deduct unreimbursed medical and dental expenses that exceed 7.5% of your adjusted gross income (AGI). This includes a wide range of out-of-pocket expenses, such as doctor visits, prescription medications, and medical equipment.
12. Qualified education expenses
Certain qualified education expenses can reduce taxes through various tax credits and deductions. Expenses may include payments for tuition, enrollment fees, and other related expenses for an eligible student.
13. Tax residency planning
In 2024, there are nine US states that do not impose a state income tax, with some states also lacking taxes on investment income. These states are ideal locations to legally claim tax residency for high-income earners, startup equity holders, and crypto investors looking to reduce their tax bill.
14. Tax-efficient investment strategies
There are various investment strategies that can help high-income earners lower their tax liability.
Long-term capital gains
If an asset is held for a year or more before selling, the gains or losses are considered long-term and are taxed at lower rates than if the asset was held for less than a year or what’s considered short-term gains or losses. Given this, long-term investment strategies can significantly reduce taxes.
Asset location
Asset location involves placing investments in the most tax-efficient accounts available to an investor, based on the tax treatment of the investment income they produce. The goal is to maximize after-tax returns by taking advantage of the different tax treatments offered by various accounts, including Traditional and Roth IRAs and 401(k)s.
Tax-efficient funds
Tax-efficient funds employ various strategies to reduce after-tax returns making them particularly suitable for taxable investment accounts. Examples of tax-efficient funds include municipal bonds ETFs and index ETFs.
529 plans
529 plans offer tax advantages designed to encourage saving for education expenses. These plans provide tax-deferred growth and tax-free withdrawals, meaning your investments grow tax-free and you can withdraw the funds tax-free for qualified education expenses. Many states offer additional tax incentives for contributions made to the state’s own plan. A common misconception of 529s is that they must be opened for a child but anyone can open a 529 with their name as the beneficiary and later transfer it to a child as the beneficiary. This allows you to invest for a longer period of time in a 529.
Municipal bonds
The main benefit of investing in municipal bonds is the interest income generated is generally exempt from federal income taxes. In addition to the federal tax exemption, the interest income from municipal bonds issued within the investor’s state of residence is also often exempt from state and local taxes.
15. Roth conversions
A backdoor Roth IRA conversion is used by individuals to contribute to a Roth IRA even if their income exceeds the IRS limits. The process involves making a contribution to a Traditional IRA and then converting that contribution to a Roth IRA. The conversion from a Traditional IRA to a Roth IRA is a taxable event, with income taxes due on any pre-tax contributions and investment earnings converted, but once in a Roth IRA, funds can grow and be withdrawn tax-free in retirement.
Additionally, high-income earners who have a 401(k) plan at work can consider a mega backdoor Roth conversion, which involves contributing post-tax dollars into their 401(k) and then rolling it into either a Roth IRA or Roth 401(k). Note that not all 401(k) plans allow for post-tax dollar contributions.
16. Real estate investing
There are multiple ways to take advantage of real estate to lower your tax burden.
Rental property depreciation
If you have rental property used for a business or another income-producing activity, the IRS allows a tax deduction for a portion of the property’s cost each year.
1031 exchange
A Section 1031 Exchange, also known as a Like-Kind Exchange, lets you defer capital gains taxes when you sell an investment property and reinvest the proceeds in a new property. In essence, it allows you to swap one investment property for another, deferring tax liability into the future.
17. Deferred income
Depending on your situation, different methods to defer employment income may put you into a lower tax bracket for a given year.
Timing when you exercise stock options
Exercising stock options such as incentive stock options (ISOs) and non-qualified stock options (NSOs) can result in complex tax liabilities. Both ISOs and NSOs have different tax treatments with the tax liability when exercising stock options largely determined by the fair market value of your shares and your income tax level. Due to the situational nature of ISOs and NSOs, it’s advantageous to work with a tax advisor to understand the tax impact of exercise stock options.
Negotiate deferred compensation
When evaluating a job offer, and depending on your compensation package, you might consider negotiating a deferred compensation plan that would allow you to take payments over a longer period of time. Income is not taxed until you receive it, and for ultra-high-income earners, deferred compensation can help reduce tax liability by potentially keeping you in a lower tax bracket.
Similarly, you may also want to consider negotiating the timing of year-end bonus payouts and other incentive income. Depending on your situation, a large bonus may cause you to enter a higher tax bracket leading to paying more in taxes.
18. Tax-efficient non-charitable giving
The IRS allows taxpayers to gift a maximum amount each year to as many individuals as desired without reporting it on a gift tax return. Called the annual gift exclusion, the maximum amount varies from year to year with the IRS defining what a gift is. In 2024, the annual gift tax limit is $18,000 for individuals, and for married couples, the limit is $36,000.
19. Environmental tax breaks
If you make energy improvements to your home, the IRS provides tax credits for a portion of qualifying expenses. Qualified improvements may include solar, wind, and geothermal power generation along with updates to exterior doors, windows, skylights, insulation materials, and more. Second homes used as residences may also qualify for environmental tax credits.
20. Tax-efficient estate planning
Working with a tax advisor, you may find that certain estate planning measures, such as establishing an irrevocable trust or parent-seeded trust, formally known as a Beneficiary Defective Inheritance Trust (BDIT), can reduce tax liabilities by removing assets from your estate. Estate taxes are complex and require a deep understanding of the tax code, making a tax advisor or tax attorney a valuable partner in creating tax-saving strategies.
Tax deduction FAQs for high-income earners
What are tax deductions?
Tax deductions, also called tax write-offs, are expenses that taxpayers can subtract from their gross income to determine their taxable income, reducing their overall tax liability.
What is Form 1098?
Form 1098, also known as the Mortgage Interest Statement, is a tax form used in the United States that lenders send to borrowers who have paid mortgage interest during the year. Additionally, there are three other variations: Form 1098-C for contributions of motor vehicles, boats, and airplanes; Form 1098-E for student loan interest; and 1098-T for tuition.
Should I take the standard tax deduction or itemize deductions?
The decision to take the standard deduction or itemize deductions on your tax return depends on your individual financial situation. When you pay taxes, you’ll want to examine both options and select the option that results in a lower overall tax liability. A credentialed tax advisor can assist you with deductions during the tax filing process.
Work with a Harness Tax Advisor
If you need help navigating tax questions around equity compensation, business ownership, self-employment, or any other unique tax situation, working with a Harness Tax Advisor can help you target your goal of reducing tax liabilities. From comprehensive planning to tax preparation, our experts are here every step of the way. Get started with Harness today.
Tax related services provided through Harness Tax LLC. Harness Tax LLC is affiliated with Harness Wealth Advisers LLC, collectively referred to as “Harness”. Harness Wealth Advisers LLC is a paid promoter, internet registered investment adviser. This article should not be considered tax or legal advice and is provided for informational purposes only. Please consult a tax and/or legal professional for advice specific to your individual circumstances.
