As a high-income earner, you probably shell out thousands of dollars in taxes every year. Naturally, you may be looking for legal ways to ease your tax burden and lower your taxable income. A common strategy for reducing a tax bill is to take advantage of tax deductions and credits.
Tax deductions lower the amount of income that’s subject to taxation by the IRS. They help reduce your taxable income, meaning you’ll pay less in taxes and preserve more of your earnings.
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Charitable contributions deductions
In addition to offering you an opportunity to help your favorite cause, donating to charity also offers you several personal benefits. One of these perks is that it allows you to reduce your tax liability, meaning you can pay less in taxes whenever you donate money.
Individuals can claim a deduction of up to $300 for any cash donations they make to charity organizations. And for couples looking to claim the standard deduction, the limit is $600 when they’re filing jointly.
Typically, the IRS limits deductions for charity donations to 60% of a taxpayer’s adjusted gross income. But the organization lifted this limit temporarily for the 2020 and 2021 tax years. Now taxpayers can take a deduction of up to 100% of their adjusted gross income.
Note that this limit applies to every donation you make throughout the year, regardless of how many charity organizations you contribute to. If the total amount you donated exceeds this limit, then you can use a process called the carryover. Carrying over basically means you’re deducting your contribution over the next five years – or until you exhaust the entire amount.
For high-income earners, charity contributions often generate more tax savings compared to low-income earners. Consider a $500 donation from a high earner in the 37% tax bracket and a similar donation amount from a taxpayer in the 10% bracket. The same donation amount will help the high-income earner save $185 in taxes, while the taxpayer in the 10% tax bracket will save only $50.
Volunteering expenses are deductible too
Remember that while the IRS won’t let you write off the value of your time and service, the organization will allow you to deduct any expenses you incurred while volunteering from your taxable income. These expenses can include mileage costs when traveling to a volunteering event or the costs of bringing items to a donation site.
Ensure you’re donating to a qualified organization
The IRS does not consider gifts to individuals, for-profit businesses, or private entities as deductible.
Eligible organizations may include:
Organizations preventing animal cruelty
Establishments dedicated to the development of amateur sports
For cemeteries, burial companies, nonprofit veterans’ institutions, and fraternal lodge groups, donations can be tax-deductible but only if they’re meant for a very specific purpose.
If you give away property that you’ve owned for more than a year, you’ll claim a deduction amount that’s equal to the property’s fair market value.
So, when it comes to appreciated property, the deduction amount you can claim is greater than if you’d have cashed in on the property and donated the proceeds to charity. The reason?
The IRS doesn’t tax you on the appreciation – you don’t pay any capital gains tax. So, basically, you’ll get a tax write-off for an amount you didn’t report as income.
Use donor-advised funds
Leveraging a donor-advised fund is one of the most tax-efficient ways to donate to charity. Once you contribute either cash or an appreciated asset through a DAF, your contribution is put into an account in your name. The money then goes to any charity of your choosing.
The benefit to using DAFs is that they allow you to claim a charitable deduction in the current year, even when you’re not aware who you’ll be donating to yet. Also, a donor-advised fund can come in handy if you want to spread out your contribution money over a couple of years but want to claim the entire deduction in the current year.
Retirement plans contributions
To have a stress-free retirement, then contributing to a retirement plan now should be a priority. With a retirement account, you can get more savings, and when the time comes to hang up your hat, you’ll have enough money to meet most of your expenses.
A recent EBRI survey revealed that retirement savers often do better financially. A chief reason for this is that they can stretch out their salaries through tax breaks. By making regular contributions to retirement accounts, you can receive significant deductions and reduce your tax burden.
If you’re a high-income earner, your tax savings can be significantly higher.
Imagine this. You make $300,000 annually, and you contribute $4,000 per year to your retirement plan. Your income places you in the 35% in the IRS 2022 tax bracket. Your tax savings will therefore be around $1400.
Contrast this to a worker earning $10200 per year. They’re contributing $1300 to their retirement account. In the 10% tax bracket, they’d save about $130. In the long run, there’s no doubt you’ll save a lot more.
That said, maximizing your contributions allows you to take full advantage of the tax-reducing perks of retirement plans. The 2022 annual limit is $20,500, an increase from the $19,500 limit imposed for the 2020 and 2021 tax seasons. Note that, if you’re aged 50 or above, you can make an extra annual “catch-up” contribution of $6,500.
Consider a Roth IRA conversion
With a traditional IRA, your contributions are deducted from your gross income – this means that the money comes from your earnings before you’ve paid your income taxes. The result? You can write off your contributions as tax deductions when you file your taxes, and you won’t owe Uncle Sam any taxes on those contributions. After retirement, though, you’ll have to pay tax on the money you withdraw.
Most high earners choose traditional IRAs, and the reason is simple. When you retire, your income will be much lower because you’ll not be earning a regular salary. And this means that you’ll belong in a lower tax bracket. So the money you’ll withdraw will be taxed by the IRS at a lower rate compared to when you received your regular paychecks.
But it might be worth considering a Roth IRA conversion.
With a Roth IRA plan, you make your contributions with after-tax dollars – this means that your contributions come after federal income tax has been deducted. So when tax season arrives, your contributions won’t be tax-deductible.
The benefit of making Roth contributions is that your money will grow tax-free, and you won’t owe any additional taxes on your investment earnings. When the time comes to withdraw your earnings, you’ll get the full amount. Earnings from Roth accounts aren't considered investment income, either, so they'll not change your modified adjusted gross income.
One of the main reasons to convert to a Roth IRA account is the lower rates offered by the Tax Cuts and Jobs Act. Considering the current market environment, and that most of the act’s provisions will expire in 2025, now’s probably the time for a short-term conversion – you can start building tax-free wealth for the future.
That said, converting to a Roth IRA may be an ideal option for you if:
You have earned less in the current year compared to the previous year
Your traditional IRA’s value is falling and converting is a more affordable option
You expect to be in a higher tax bracket when your retire
You have extra money, outside of your retirement plan, that you’d use to pay the tax for the conversion
Health Savings Account contributions
Contributing to a Health Savings Account offers three significant tax benefits – it allows you to deduct your contributions, lets you make withdrawals without paying any tax, and allows your money to grow tax-free. That's why it's one of the most popular tax reduction strategies.
You make your contributions with pre-tax dollars, as the money is deducted from your payroll. These contributions are not part of your gross income and are therefore not subject to income taxes.
If you allow your money to sit in your HSA, it will accumulate interest. This interest is tax-free and can add up, meaning you’ll have more money to use for qualified health expenses.
HSA withdrawals aren’t subject to federal taxes, provided that you’re using them for qualified medical expenses. Note, though, that this only applies if you’re aged under 65. If you’re over 65, your withdrawals can be for any use.
Another benefit is that you can turn your HSA into an investment account where you buy stocks that will help you increase your returns in the future.
That said, here are the maximum annual contribution limits for 2021 and 2022:
2021: For individual coverage, the limit is $3,600. For family coverage, the limit is $7,200.
2022: For individual coverage, the limit is $3650. For family coverage, the limit is $7,300.
If you’re 55 or older, you have the option of adding an extra $1,000 to your contributions.
A major benefit of being an independent contractor is that you can write off any expenses that you incur when running your business. The amount you write off depends on the percentage of business use of a particular asset.
For instance, let’s say you use your phone 30% of the time for business calls, and the other 70% of the time to catch up with your friends and relatives. The IRS allows you to write off 30% of your cellphone bill and claim it as a deduction.
Depending on your profession, there are a lot of deductions you can claim, but here’s a quick overview of the most popular ones.
If your 1099 job requires you to advertise your services regularly, then you can claim the advertising and marketing deduction when you pay taxes.
The cost of any tools you use for your business – such as cameras, laptops, or software – can be deducted when you file your tax return.
Traveling can eat up a huge chunk of your budget. Luckily, the IRS allows you to deduct any travel expenses you incur for business trips.
If you’re learning to get better at your profession, then you can write off the costs of your education courses and learning material. This can also apply to you if you regularly pay for workshops and seminars.
As a small business owner, understanding the various IRS-required forms for subcontractors is absolutely essential to remain compliant. This guide will let you know all about creating 1099 forms and what types of forms you may need..