Tax planning strategies are always important, but when you have a higher net worth, getting everything right becomes even more critical. By implementing tax strategies for high-income earners, you can preserve more of your earnings and wealth over time. This can help you leave a larger financial legacy for your loved ones through your estate plan.
Tax Planning for Investments
Your investments can generate current income and long-term wealth, but it’s important to consider the tax implications. Selling investments for a profit can lead to capital gains tax liability.
Long-term capital gains tax applies to investments you have held for more than one year, while short-term capital gains tax applies to investments you have held for less than one year. Long-term capital gains rates are 0%, 15%, and 20% with maximum income thresholds. Short-term capital gains tax is always taxed at the same rates as ordinary income.
This means that if you are in a higher tax bracket, you will pay more short-term capital gains tax when selling investments. For example, if you are single and earn more than $539,900 or more, you will be in the 37% tax bracket for the 2022 tax year, which you will file in 2023.
Tip: Before selling investments in your portfolio, estimate how much tax you might owe.
Note: Tax-loss harvesting, which involves selling losing investments to offset capital gains, can help reduce your tax bill.
Tax Planning for Inheritances and Gifts
The Tax Cuts and Jobs Act (TCJA), which took effect in 2017, introduced opportunities for tax savings for millions of Americans, including those in higher tax brackets. If you are interested in tax planning for the high net worth, here are some of the most important considerations.
Tax Planning for Inheritances and Gifts
The TCJA made changes to inheritance and gift taxes that directly affected high net worth individuals. Specifically, the law doubled the tax exemptions for gifts and inheritances and generation-skipping transfers. In 2022, for example, the estate tax exemption is $12.06 million per individual. The annual gift tax exclusion is $16,000 per individual in 2022, while the tax rate for both remains fixed at 40%.
The lifetime exemption limits mean you have more opportunities to leave wealth for future generations while minimizing taxes during your lifetime. To fully leverage the tax changes while they last, it is important to consider whether your current estate plan is designed to allow you to take advantage of the maximum estate tax exemption, ensuring that you do not pass on more (or less) of your wealth to your spouse, children, or grandchildren than you intend during your lifetime. You should also coordinate your federal estate tax strategies with any potential tax implications at the state level.
Tax Planning for Charitable Donations
Charitable contributions can be one of the most attractive tax shelters for high-income earners who want to do good while receiving a tax break. The IRS allows you to deduct cash contributions to qualified charitable organizations, with a maximum deduction of up to 60% of your adjusted gross income (AGI).
The higher deduction limits are an advantage for high net worth individuals who itemize deductions on Schedule A. For example, you can make large tax-free wealth transfers by placing some of your assets into a charitable remainder trust. If you are over 70 and a half, you can avoid paying income tax on up to $100,000 in charitable donations made annually from a traditional IRA for an additional tax benefit.
Note:
Creating a Donor-Advised Fund (DAF) can also lead to an upfront tax deduction.
Pass-Through Entity Income Deduction
Another key tax issue high-net-worth individuals should consider is the potential impact of the 20% deduction on business income for pass-through entities. If you operate a business that is structured as a pass-through entity, you may be able to deduct 20% of your qualified business income directly off the top, subject to certain limitations. If you are a high-income earner who owns a business, you may want to explore the benefits of forming a limited liability company to take advantage of this deduction.
If your company operates as a C Corporation, you will not be able to benefit from the deduction, but the Tax Cuts and Jobs Act reduced the corporate tax rate from 35% to 21%, providing another potential way to save on taxes.
Tax Strategies to Avoid
When implementing tax strategies for high-income earners, it’s important to ensure that you are only seeking legal and ethical methods. There is, after all, a difference between minimizing taxes and outright tax evasion, which can lead to penalties from the IRS and, in the worst cases, criminal charges.
For example, submitting inaccurate tax reports regarding income is a form of tax evasion, as is claiming excessive or fictitious tax deductions. Consulting with a trusted tax professional can help you create a strategy to reduce your tax liability and preserve wealth while staying on the right side of the IRS.
Frequently Asked Questions
What is a high-net-worth individual?
The term high-net-worth individual (HNWI) can be used to describe people with assets that meet a certain threshold. Some wealth management firms classify individuals with liquid assets over $1 million as high-net-worth individuals. The U.S. Securities and Exchange Commission may classify investors as high-net-worth individuals or “qualified purchasers” if they have at least $750,000 under the management of a financial advisor or have a net worth of more than $1.5 million.
What is estate tax?
Estate tax is the tax imposed on your right to transfer your assets to your beneficiaries after your death. To calculate the estate tax, you must consider all of your assets. The assets counted for estate tax include cash and securities such as stocks and bonds, real estate, insurance, trusts, bonds, business interests, and other assets.
Source: https://www.thebalance.com/high-net-worth-tax-planning-strategies-5193312
Source: https://www.thebalancemoney.com/high-net-worth-tax-planning-strategies-4161014
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