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.
In this article, we’ll look at the most common types of tax strategies for high-income earners and how you can make the most use of them. Let’s get started.
Note: if you are a high income earner, you'll want to lower your taxable income as much as possible. Bonsai Tax could help. We'll scan your bank/credit card receipts to discover your potential tax write-offs and maximize your tax deductions. In fact, the majority of our users save, on average, $5,600 from their tax bill. Try a 14-day free trial of our software today.
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.
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.
The IRS does not consider gifts to individuals, for-profit businesses, or private entities as deductible.
Eligible organizations may include:
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.
You can use the IRS Tax Exempt Organization Search website to determine whether you’re donating money to eligible organizations.
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.
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.
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.
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:
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:
If you’re 55 or older, you have the option of adding an extra $1,000 to your contributions.
If you are self-employed, read more tax hacks here.
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 you run your business from home – either as an influencer, freelance writer, or graphic designer – you can write off a percentage of your rent or mortgage. Read more on how to claim a home office deduction here.
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.
Business meals and entertainment tax deduction is huge. If you’re a real estate agent, for instance, you may need to meet with potential clients once in a while. The expenses you incur for meals and entertainment in these meetings are 50% deductible.
A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.
Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.
Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.
The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.
Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.
For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.
If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.
That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.
There are some types of contracts which must be in writing.
The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:
Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.
Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.
Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?
Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!
If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.
Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.
Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.
So, ultimately, the question is: written or verbal agreements?
Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.
Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.
Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.
There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.
A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.
Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.
With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.
Why not secure your business today and sign up for a free trial?