5 Smart Ways On How To Reduce Taxable Income For High Earners

How To Reduce Taxable Income For High Earners

Paying taxes is unavoidable, but there are numerous opportunities to help lower a tax bill. Recently, I came across a finance forum for doctors that piqued my interest. One of the most highly viewed posts was, “How To Reduce Taxable Income For High Earners.”

Most high income earners that I know are constantly looking for ways to lower their tax bill.

As tax day looms nearby, I thought this would be a perfect time to discuss.

Let’s get going…

5 Smart Ways On How To Reduce Taxable Income For High Earners

1) Save Towards Retirement

saving for retirement

The simplest way to begin reducing your taxable income starts by maxing out your retirement accounts. Deferring as much tax as possible early on during the working years and taking advantage of tax-deferred plans is a must.

For employees, you may have access to plans such as:

These types of employer-sponsored retirement plans provide employees with an automatic way to save for their retirement while benefiting from tax breaks.

Many of these plans also come with an employer match which is virtually “free” money no matter what annual interest rate is earned.

Pre-Tax

When employees contribute to these types of accounts, they are done so using “pre-tax” dollars. What this means is that the money goes directly from the paycheck into the plan before the deduction of taxes. The end result is that less income is now being taxed.

Contribution Limits

Starting in 2019, you can contribute up to $19,00 per year of your gross income in 401(k) plans. If you’re over the age of 50, you’re able to make “catch-up” contributions up to $6,000. This brings the annual contribution up to $24,500.

Self-employed

For those that don’t have the option of an employer-sponsored plan or are self-employed, consider contributing to accounts such as a:
  • SEP-IRA
  • Solo 401(k)
Both of these plans provide an opportunity to lower your taxable income through pretax contributions.

Solo 401(k): The business owner wears two hats in a 401(k) plan: employee and employer. Contributions can be made to the plan in both capacities. 

The contribution limit is up to $56,000 in 2019. There is a catch-up contribution of an extra $6,000 for those 50 or older.

Nerdwallet.com gives us a breakdown of those limits:

  • As the employee, you can contribute up to $19,000 in 2019, or 100% of compensation, whichever is less. Those 50 or older get to contribute an additional $6,000 here.
  • As the employer, you can make an additional profit-sharing contribution of up to 25% of your compensation or net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself. The limit on compensation that can be used to factor your contribution is $280,000 in 2019.

SEP-IRA: Is another way to lower your tax bill for business owners/self-employed individuals.

The annual contributions made to a SEP IRA cannot exceed the lesser of:

  • 25% of compensation
  • $56,000 in 2019

2) Take Advantage Of Health Savings Accounts

Health Savings Accounts (HSAs) are the only accounts that offer a triple-tax advantage.

What this means is that:

  • Contributions are tax-deductible
  • It grows tax-free
  • Money is taken out and not taxed

HSAs are available only if you’re enrolled in a high-deductible health plan (HDHP). These are insurance plans with a high deductible, and maximum out of pocket costs.

For 2019, the IRS defines a HDHP as:

  • Individual – out-of-pocket maximum of $6,750, minimum deductible of $1,350
  • Family plan – out-of-pocket maximum is $13,500, minimum deductible is $2,700

Contribution Limits

HSA contribution limits for 2019 are:

  • $3,500 for individuals
  • $7,000 for families
  • $1,000 55+ catch-up contributions

Maximize HSAs

As a high-income earner, if you REALLY want to maximize the tax-savings potential of an HSA, then consider doing what we did before we switched to Medi-Share.

For years, while we contributed to our HSA, we paid all medical expenses with out of pocket money. We did this instead of dipping into the HSA.

Now, so far, we’ve blessed to have our health which has kept our out of pocket medical expenses minimum over the years (except an occasional ER trip – if you have boys, then you know what I’m talking about.)

If you have financial discipline to pull this off, then your HSA balance will continue growing tax-deferred until retirement.

3) Start A Side Gig

Little Debt Free and Friend with Shark Tank host and Dallas Mavericks owner, Mark Cuban.

One of the few shows my entire family watches together is Shark Tank. It gives hope to the average, everyday “Joe” that has an idea.

As Walt Disney stated best, “If you can DREAM IT, you can DO IT.”

Watching a few episodes can spur someone to take an idea that they’ve had and turn it into a business.

For a high-income earner, becoming an entrepreneur is another way to lower the overall tax bill and you can do it without being on Shark Tank!

There are numerous sites that discuss this topic such as:

4) Give More

If you’re a regular reader here, then you’ve heard me talk about how money and stuff won’t make us happy.

You may have also heard of the Hedonic Treadmill which is the tendency of a person to remain at a steady level of happiness despite changes in fortune or the achievement of major goals.

As a person makes more money, expectations and desires rise in tandem, which results in no permanent gain in happiness.

If making and getting more doesn’t result in happiness, then what does?

There’s been tons of research and books written about this very topic and the bottom line is this:

  • Things don’t make us happy
  • Experiences (especially with friends and family) bring us joy
  • Giving and helping others in need makes us happy

Don’t worry, be happy…and give

Consider giving to not only lower your tax bill, but also make you a happier person. What a great win-win situation.

Taxes Taxes Taxes

 Tax Brackets and Rates, 2019
RateFor Unmarried Individuals, Taxable Income OverFor Married Individuals Filing Joint Returns, Taxable Income OverFor Heads of Households, Taxable Income Over
10%$0$0$0
12%$9,700$19,400$13,850
22%$39,475$78,950$52,850
24%$84,200$168,400$84,200
32%$160,725$321,450$160,700
35%$204,100$408,200$204,100
37%$510,300$612,350
Here’s a breakdown of the taxes currently in effect for high income earners:
  • Top ordinary income tax rate – 37%
  • Top long-term capital gains tax rate – 20%
  • Medicare surtax of 3.8% on net investment income

Give Smartly

I get it. High income earners are taxed to the hilt. Whenever you give, instead of writing a check, take a look at your portfolio first. Consider giving appreciated stocks or mutual fund shares that you’ve owned for more than one year instead of cash.

Why? Capital gains taxes are eliminated when you contribute long-term appreciated assets directly to a charity instead of selling the assets yourself and donating the after-tax proceeds.

When you assume 20% for federal long-term capital gains taxes, plus a 3.8% Medicare surtax, this leads to a potential increase of 23.8% of both your tax deduction and your charitable contribution.

Here’s an example from Fidelity on how donating appreciated securities can reduce taxes:

5) Invest In Real Estate

One of the best ways to not only build wealth but lower your taxes involves investing in real estate. It was also discussed recently on the list of ways to invest $50K.

Some of the benefits include:

  • Ability to recover the cost of income-producing property through depreciation
  • Using 1031 exchanges to defer profits from real estate investments
  • Personal residence exemptions – helps with capital gains taxes
  • Mortgage interest deduction

Passive Income MD recently discussed these benefits plus others in this article:

7 Great Tax Benefits of Investing in Real Estate

Sam, over at Financial Samurai, knows all about rental property and gives us his insight on how it can also lower taxes:

Three Favorite Ways To Earn Money And Pay Less Taxes

Conclusion

I’m not a tax strategies or CPA (nor do I play one on TV). Before making any decisions involving tax strategies/planning, consult the professionals you work with and trust. A little bit of planning can go a long way.

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One comment

  • Great job, very comprehensive and helpful content. I was contributing to a SEP and later realized the advantages of a Solo 401(k), which I have now. Solo is an awesome way to save more and reduce taxes for sure. Again, great post.

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