Tax deductions can be broken down into two important categories: above the line deductions and below the line deductions. The “line” is a reference to your adjusted gross income (AGI).

Above the Line Deductions for 2022

Above the line deductions reduce a taxpayer's adjusted gross income and are allowed regardless of whether you itemize or take the standard deduction. Above the line deductions are important because reducing your AGI may help you qualify for additional deductions or credits on your return. High-income earners may consider the following above the line deductions:

• Health savings account contributions. HSAs are triple tax-advantaged accounts: Contributions are tax-deductible, the money grows tax-free, and withdrawals are tax-free for qualified medical expenses for those under age 65, and for any purpose if you are age 65 or over. The contribution limits for 2022 are $3,650 for individuals and $7,300 for families. If you are age 55 or over, you can contribute an extra $1,000.
• Deductible Traditional IRA contributions. Contributions to Traditional IRAs are deductible with different income thresholds based on if you have access to a group retirement plan or not. If you and your spouse do not have access to a group plan then there is no income limit for taking the deduction. The MAGI limit to deduct contributions for a married couple with just one spouse having access to a group retirement plan is $204,000 - $214,000. If both spouses have access to a group plan then the MAGI limit for the deduction is $109,000 - $129,000. For a single filer who has access to a group retirement plan, the MAGI limit is $68,000 - $78,000.
• Qualified retirement plan contributions. Many employers offer qualified retirement savings plans such as 401(K), 403(b), and 457 plans to help attract qualified employees. If your employer offers one of these plans, this is one of the easiest ways for high-income earners to reduce taxes. Reductions occur directly on your paycheck and don’t even appear on your tax return. The income stated on IRS form 1040 is net of any pre-tax retirement plan contributions.
• Qualified charitable distributions. A qualified charitable distribution (QCD) is a distribution from an IRA owned by an individual age 70 ½ or over that is paid directly from the IRA to a qualified charity. In simple terms, the IRS allows you to pay organizations like your church or favorite charity tax free from your IRA. A QCD has the potential to save you thousands of dollars in taxes if you are charitably inclined.

Below the Line Deductions

Below the line deductions, also known as standard deductions or itemized deductions, are determined after calculating your AGI. Unfortunately, not all below the line deductions will lower your taxable income. According to estimates, nearly 90% of taxpayers will end up taking the standard deduction rather than itemizing deductions. In 2022, the standard deduction is $12,950 for individuals, $25,900 for married filing jointly, and higher for the blind and individuals age 65 plus.

Itemizing deductions is much harder for high-income earners than in years past. If you plan ahead, there is serious potential to reduce your tax further by itemizing your deductions. Tax reduction strategies may include:

• Charitable contributions. There are many strategies to help you maximize your charitable contributions and reduce your income tax. High-income earners should consider donating low cost basis stock, contributing to a donor advised fund, or stacking future charitable donations in a single year to maximize tax deductions.
• Mortgage interest expenses. If you currently rent or have a lot of consumer credit card debt, you may consider purchasing a home or doing a cash-out refinance to take advantage of deducting mortgage interest. In 2022, up to $750,000 in principal financed may be tax deductible.
• Medical expenses. Keep track of your medical expenses. While you may be healthy, it’s possible that larger families or a one time medical need could allow you to deduct a portion of your medical expenses. In 2022, medical expenses that exceed 7.5% of your AGI may be deducted as an itemized expense.

Income Deferral or Acceleration.

Deferring or accelerating taxable compensation isn’t the right approach for every situation, but it may reduce your exposure to income and capital gains taxes and the 3.8% Medicare surtax on investment income.

Income deferral isn’t just about deferring income in the current year. Tax savvy individuals know that creating a long-term income deferral strategy can help you compound your savings and investments at a faster rate.

One thing to keep in mind as you consider tax reduction strategies for high-income earners is that the current tax rates are temporary and slated to expire in 2025; income you defer in 2022 may actually be taxed at a higher rate later on.

Key income strategies to consider:

Consider non-qualified deferred compensation contributions. If your employer offers a deferred compensation plan you can reduce your taxable income this year and build your post-retirement savings.

Ask your employer to defer income until 2023. Are you having a big year for commission income? If so, your taxable income may be higher this year than next year.. If you plan on receiving commissions or other types of earned income late in 2022, consider asking your employer to defer paying your income until 2023. If your taxable income is going to be lower next year, deferring your income until next year could reduce your tax burden by transferring the income to a lower tax bracket.

Delay or accelerate IRA withdrawals upon retirement. Depending upon your tax bracket, you may benefit from accelerating or delaying IRA distributions until a later date. For example, converting traditional IRA savings to a Roth IRA may be advantages if you plan to be in a higher tax bracket in the future. Conversely, you may consider delaying IRA distributions if you need to reduce your taxable income this year. Either strategy may help smooth out your tax brackets over time thereby reducing the income tax you pay in retirement.

Income Tax Deferral

Tax-deferred investment vehicles aren’t the same as tax-exempt (such as a Roth IRA or HSA accounts); at some point, there will be tax consequences associated with the distribution of the assets. However, tax-deferred accounts can be an effective tax strategy for high-income earners to reduce current year tax liabilities. Additionally, tax-deferred accounts benefit by compounding returns faster by sheltering income from current taxation.

Here are three tax-deferred investment vehicles to consider:

Qualified retirement plans. Contributing to a 401(k), 403(b) or 457 plan is one of the easiest ways to defer investment income. As noted above, the SECURE Act lets high-income earners age 50 and over save $27,000 a year in a 401(k) so you have more control over when you retire. Your earnings are sheltered from tax until withdrawal which mean won’t pay tax on dividends, interest and capital gains until you actually take a distribution from the account at age 59 ½ or later.

529 plans for education. You pay federal taxes on your contributions, but the money grows tax-free and distributions for qualifying educational expenses are not taxed. There are no annual contribution limits, but starting in 2022 contributions above $16,000 per donor per beneficiary count against the lifetime estate and gift tax exemption. For Virginians who want to know how to reduce Virginia income tax, up to $4,000 per account per year is deductible for state income tax purposes. Money in these accounts can now be used to cover private school tuition of up to $10,000 per year.

Consider cash-value life insurance. This is one of the most popular tax deferral strategies for high-income earners because of higher limits that can be invested. You make contributions with after-tax dollars, but the money can grow tax-free and withdrawals up to the amount of premiums paid are not taxed.

Change the character of your income

You can adjust the assets in your portfolio to change the way your income is taxed. If you own a business, changing your business structure can be a very effective tax reduction strategy for high-income earners.

Here are some options:

Convert your traditional, SEP, or SIMPLE IRA to a Roth. After age 59-½ (if you’ve met the five-year rule), Roth distributions are generally tax-free. In addition, they aren’t considered investment income, so they won’t increase your MAGI for the 3.8% Medicare surtax. You’ll need to analyze your federal tax brackets, but Roth conversions can be a powerful tool to reduce the taxation of your future income.

Buy tax-exempt bonds. Interest income from tax-exempt bonds is excluded from Medicare surtax calculations and not subject to federal income tax. Even better, municipal bond interest on bonds purchased in your state of residence are state and federal income tax free.

Restructure your business entity. Incorporating your business lets you choose the tax structure that works best for you financially. A C-corp, for example, has a lower top tax rate than an S-corp or sole proprietorship. In addition, earnings from a pass-through entity may also qualify for a new deduction of up to 20% of business income. Switching to a sole proprietorship lets you hire your minor children without having to withhold or match payroll taxes. Children’s earnings are also taxed at a lower rate.

Invest Your Health Savings Account contributions. Many high-income earners either don’t use an HSA at all or they use it incorrectly. If you qualify for a Health Savings Account, consider investing your HSA contributions for the long-term instead of spending them on current medical expenses. Earnings will grow tax free and future distributions are tax free if used for a qualified medical expense.

Invest in tax-efficient index mutual funds and exchange-traded funds (ETFs). Every high-income earner should have a plan to diversify the taxation of income in retirement. For taxable accounts, a tax-efficient index mutual fund and/or ETF may help reduce the taxes you pay on your investments year-to-year. Index funds and ETFs can be more tax-efficient than actively managed funds.

Time your gains or losses

Effective tax strategies for high-income earners should include managing the timing of large gains so you aren’t subject to the Medicare surtax or pushed into the 20% capital gains bracket.

Here are some techniques to manage your gains:

Establish and contribute appreciated positions to a charitable remainder trust. Charitable remainder trusts disperse income to beneficiaries for an established period of time before the remainder is donated to charity. By contributing a long-term, appreciated asset, you avoid incurring tax on the gains and get a deduction based on the current value of the gift.

Invest in a Qualified Opportunity Fund (QOF) . These were created in the Tax Cuts and Jobs Act and allow you to defer taxes on capital gains until 2026 by investing them in a QOF within 180 days of the sale. Taxes can be reduced by holding onto the investment for at least five years.

Harvest unrealized losses on your investments. When stock markets fall, you may consider selling investments in taxable accounts that have losses. A strategy known as tax-loss harvesting allows you to sell your investments to capture your losses on paper. In 2022, the IRS allows taxpayers to deduct up to $3,000 in losses against regular income and allows you to offset losses with current and future year capital gains. Losses not used in the current year can be carried forward to subsequent years.

Bundle your 529 plan contributions

If you want to maximize your family gifting, there is a special provision for 529 plans. Under the law, an individual can give up to $75,000, or five years’ worth of gift-tax exemptions, in a single year as an initial contribution to a student’s 529 plan.

It’s worth noting that any additional gifts to that same student over the next five years will reduce your lifetime exclusion. However, the student gets the benefit of kickstarting his account and the cash has more time to compound and grow.

Conclusion

Wealth management is complicated. It takes more than finding the right tax reduction strategies for high-income earners to ensure your money is working for you in the most efficient way possible.

The right financial advisor makes all the difference.

Our first priority is helping you take care of yourself and your family. We want to learn more about your personal situation, identify your dreams and goals, and understand your tolerance for risk. Long-term relationships that encourage open and honest communication have been the cornerstone of my foundation of success.