If you’re a high-income earner wanting to reduce your taxable income, start with these five strategies.
Max Out Your 401(k)
The contribution limit for an individual in 2021 is $19,500. A married couple can reduce taxable income by $39,000. That’s a tax saving between $9,360 (24% marginal rate) and $14,430 (37% marginal rate). As a high-income earner, contributing to your employer-sponsored plan is the easiest way to reduce your taxable income.
Have a Plan for Your Non-Retirement Account Assets
Most transactions in a brokerage account are taxable. Selling positions, receiving dividends, interest, and capital gain distributions are all taxable events. How each is taxed varies. Because each transaction likely has a tax consequence, you should consider: what you own – is it tax-efficient and how long you’ve held it – will you pay short- or long-term capital gains? Work with your financial planner and tax professional to implement a plan specific to your needs.
An estimated 86 percent of taxpayers use the standard deduction. Unless you itemize, your donations to qualified charities are not tax-deductible. Bunching is a strategy where you ‘bunch’ deductions into one year. If you are part of the 86% that takes the standard deduction, this strategy may work for you.
By following option 2 and bunching your charitable contributions into one year, you gained $8,600 of additional tax deductions over two years.
Donor Advised Funds (DAF)
Many high-income earners are adding DAFs to their financial plan to achieve their charitable giving intent. The DAF is a charitable savings account that lets you decide whom you’ll donate to without having to specify the organization right away. Using the table above, you can make a $20,000 tax-deductible contribution, invest the money in the DAF, and later decide how and to whom you’ll distribute the money.
The tax deduction is limited to 60% of your adjusted gross income (AGI) for cash gifts. For long-term marketable securities, your deduction is limited to 30% of your AGI.
Note: For 2021, the CARES Act increased the cash contribution limit from 60% of your AGI to 100% of your AGI.
Contribute to Your HSA
The limits for HSA contributions are $3,600 for self-only plans and $7,200 for family plans. The contributions provide a dollar-for-dollar deduction like an IRA contribution. The benefits of an HSA are pretty incredible if you are edible to participate.
These five tax planning strategies are the tip of the iceberg and the most common. Because tax planning is specific to the individual taxpayer(s), you should allocate time with your financial advisor and tax professional to create a plan specific to you. Remember, not all tax strategies can be implemented at year end, so creating a plan early in the year with your team is critical.