Tax Strategies for High Income Earners: The Trial Tax Return

Preparing a strategy that is both advantageous and tax-efficient might feel daunting at first. Thankfully, there are some tax strategies for high income earners you can do now to keep from overpaying this tax season.

You might build a team for any number of pursuits, from organizing a baseball team to putting together people to run a business. Any team is not only an organization of people, but also a combination of talents.

Building a financial team to tackle your taxes may often mean talking to more than one person. Your trusted financial professional can speak to a wide range of financial issues, but they may want to consult others who have specialized training. At Buttonwood, we strategize with many tax professionals allowing us to pair their expertise directly with our client’s needs.

We recommend doing a trial tax return before year-end to assess your tax implications, thus allowing for current year action to maximize tax opportunities.

At Buttonwood, this process starts by duplicating 2020 tax return data and updating the data for 2021. To obtain updates, run reports via a financial planning portal. Focus on taxable account gains, losses, dividends, and interest. In addition, update changes to social security and 1099 income. Finally, run a P&L via your accounting software for business entities to complete Schedule C, E or F. Details from these reports can be provided to your CPA for a more accurate view of your 2021 tax liability. This leaves time in the current year to proactively manage your tax bill. If you don’t have a financial planning portal or accounting software, we do and are here to assist.

If you may find you had a lower income year in 2021. If that is the case, you could create additional income to fill up lower tax brackets for 2021; a strategy we strongly recommend. This could be done through a Roth conversion.

If your income was higher in 2021, can reduce your income by adding to retirement plans, making large business purchases this year for depreciation, making charitable contributions, opting for an elective medical procedure, etc. If you had a liquidity event in 2021, we recommend utilizing a donor advised fund.

By doing a trial tax return, you may find some key tax strategies for high income earners. Contact us today if you would like to explore existing strategies.

Once you have the right team of financial professionals who understand your financial situation, there are some investment strategies you may want to consider.

With income over $400k, this strategy is on the chopping block with Biden administrations recent tax proposal. However, for now, if you are a high earner with an income above the IRS’s income limit for Roth IRA accounts, you may have the option to create a backdoor Roth IRA. Just as it sounds, this option allows high earners to bypass the income limits and still utilize the tax advantages of a Roth IRA account.

To create a backdoor Roth IRA, you’ll need to:

A backdoor Roth IRA may be beneficial for those whose income level is above the ceiling limit set by the IRS. Additionally, it’s important to remember that Roth IRAs do not have required minimum distributions (RMD’s), only traditional IRAs do.

When considering a backdoor IRA, or Roth conversion, evaluate the tax obligations you might pay today versus the tax benefits you may realize toward retirement.

Smart moves can help you manage your taxable income and taxable estate. For instance, if you’re making a charitable gift, giving appreciated securities that you have held for at least a year is one choice to consider. In addition to a potential tax deduction for the fair market value of the asset in the year of the donation, the charity may be able to sell the stock later without triggering capital gains.

The annual gift tax exclusion provides a way to remove assets from your taxable estate. You may give up to $15,000 ($30,000 if you are married) to as many individuals as you wish without paying federal gift tax, so long as your total gifts keep you within the lifetime estate and gift tax exemption of $11.7 million for 2021. ¹

The more you can shelter, the more complex the rules. Defined Benefit, Define Contribution, Self-employed 401(k), SEP and SIMPLE Retirement plans are all examples of options where contributions can reduce your taxable income.

Tax-loss harvesting refers to the practice of taking capital losses (you sell securities worth less than what you first paid for them) to help offset the capital gains you may have recognized. While this doesn’t get rid of your losses, it can be an effective approach to manage your tax liability.

Up to $3,000 of capital losses in excess of capital gains can be deducted annually, and any remaining capital losses above that can be carried forward to, potentially, offset capital gains next year. ²  But remember, tax rules are constantly changing, and 2022 is shaping up to look different than 2021!

By taking losses this year and carrying over the excess losses into the next, you can potentially offset some (or maybe all) of your capital gains next year. Before moving ahead with a trade, it’s important to understand the role each investment plays in your portfolio.

If you’re looking into this strategy, familiarize yourself with the IRS’s “wash-sale rule.” This rule indicates that investors can’t claim a loss on a security if you buy the same or a “substantially identical” security within 30 days before or after the sale. ²

With these strategies in mind, there are things you may be able to do in 2021 to address both your current tax obligation and those you may be required to address further down the road. We know this can be a lot to digest, and even more to actually implement. Our team stands ready to assist and implement tax strategies for high income earners and more. Contact us today to get started.

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