One of the key ingredients to preserving wealth is to take control of your tax liability year after year. But as a high earner, you face some additional challenges in doing so. Primarily, your taxable income may subject you to certain income caps or surcharges while making you ineligible for certain deductions or credits.
To help address these hurdles and tackle tax season head-on, here are five of our top tax planning tips for 2023.
Secret #1: Above-the-Line Deductions
Above-the-line deductions can reduce a taxpayer’s adjusted gross income (AGI). The exciting thing is these types of deductions can be used whether you choose to itemize or take the standard deduction. These can be especially helpful, considering around 89% of taxpayers choose not to itemize.1
Using above-the-line deductions to reduce your AGI is important since your AGI is used to determine eligibility for other credits or deductions. Reducing your AGI can be especially advantageous as a high-earner since your taxable income may otherwise make you ineligible for certain benefits.
Above-the-line deductions were so named because they used to be listed on a Form 1040 above the line where your AGI was calculated. By subtracting these deductions from your income for the year, you determine your AGI. Then, you can decide to either take the standard deduction or itemize.
In addition to those below, common above-the-line deductions include:
- Self-employment tax: You may deduct half of the self-employment tax that your employer would have paid (if you were employed by someone other than yourself).
- Alimony: If you were divorced before Jan. 1, 2019, you may deduct alimony payments from your taxable income.2
- Student loan interest: You can deduct up to $2,500 in student loan interest paid per year if you meet the AGI income limit.3
If you’re offered the opportunity to use a health savings account (HSA) through your workplace health plan, you should consider taking advantage of it. HSAs are great savings tools that offer triple tax benefits for high earners.
First, the contributions made to an HSA are tax deductible. They’re considered above-the-line deductions, meaning (as discussed earlier) they can help lower your AGI. Secondly, the money in your HSA grows tax-free as well. Unlike a flexible savings account, you are not required to use the money in your account by a certain date. It rolls over year after year, and you can take it with you even if you leave your job or health plan.
And finally, withdrawals from an HSA are tax-free as long as they are used on a qualifying medical expense. Examples include prescriptions, doctor visits, hospital bills, and medical equipment.
HSAs can be great retirement savings tools as well. You can keep money in the account for as long as you like. If you withdraw after age 65, the withdrawals are tax-free and can be used for any purpose, not just qualifying medical expenses.
To be eligible for an HSA, you do need to be on a high-deductible health plan (HDHP), and they do include contribution limits.
For 2023, the contribution limits are:4
- Single filers: $3,850
- Joint filers: $7,750
- Catch-up contributions (for those 55 and older): $1,000
Retirement Plan Contributions
Eligible contributions to a traditional 401(k), 403(b), or Individual Retirement Account (IRA) can count as above-the-line deductions.
Just like HSAs, however, there are income limits for retirement plan contributions. In addition, if you are eligible for a group retirement plan (such as one sponsored by your or a spouse’s employer), you may not be allowed to deduct contributions made to an IRA.
The 2023 contribution limits for retirement plans are:5
- Traditional IRA: $6,500 (plus $1,000 in catch-up contributions)
- 401(k) or 403(b): $22,500 (plus $7,500 in catch-up contributions)
Qualified Charitable Distributions
If you are 70 1/2 or older, you can make a qualified charitable contribution directly from your IRA to an eligible charity. These are above-the-line distributions and will help lower your taxable income.
Secret #2: Below-the-Line Deductions
Below-the-line deductions refer to those deductions that are determined after your AGI has been calculated. These are the items you would deduct if you chose to itemize your deductions rather than the take the standard — as both itemized and standard deductions are below the line.
Common examples of below-the-line or itemized deductions include:
- Medical expenses exceeding 7.5% of your AGI
- Charitable contributions
- Mortgage interest (on a mortgage up to $750,000)
- Qualifying state and local taxes
Secret #3: Income Deferral or Acceleration
Using the technique of income deferral or acceleration can reduce your income and your capital gains taxes.
Deferring income allows you to delay receiving income or revenue until the following year. On the other hand, income acceleration is when you bring money into the current tax year rather than having it count toward your taxable income the following year.
When would you use these strategies? If you believe you’ll be in a lower tax bracket this year rather than next, you may want to accelerate your income. And the opposite may be true; if you expect to be in a lower tax bracket next year (say, as you enter retirement), you may wish to defer income until then.
Remember that this is commonly used by commission-based or self-employed individuals, as salaried employees may not have the option to defer or accelerate their income.
Secret #4: Strategically Time Your Gains and Losses
You can turn your losses into tax advantages by being strategic with your investments.
Tax-loss harvesting refers to the common strategy of selling your investments at a loss and deducting those losses from your taxes. By deducting losses, you can help offset the capital gains tax (or at least a portion of it) on investments that have made a profit during the tax year.
There are plenty of rules and stipulations to know when using this strategy, and discussing tax-loss harvesting and capital gains tax strategies with your CPA may be helpful.
Tax-Conscious Financial Planning With PIFP
While tax season is fully in swing, it’s helpful to consider what you can do to lower your taxable income for the year and reduce your tax liability. At PIFP, we work with high earners to make tax-conscious decisions all year. If you’d like a head start for 2023, feel free to reach out to us.
1How Did the Trump Tax Bill Affect Itemized Deductions? – 2021 Study
2Topic No. 452 Alimony and Separate Maintenance
3Did you know that the Internal Revenue Service (IRS) provides tax benefits for education?
4IRS Announces Spike in 2023 Limits for HSAs and High-Deductible Health Plans5Taxpayers should review the 401(k) and IRA limit increases for 2023
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To learn more, visit https://partnersinfinancialplanning.com