Tax Planning Strategies for High Income Earners

A tax bracket is a range of income levels that determines the rate at which individuals or households are taxed. The US uses a progressive tax system, which means that as your income increases, you tax rate generally increases as well. Each bracket has a specified tax rate that applies to income falling within that range. The tax rates for each bracket are typically expressed as a percentage of your taxable income.

Here are the federal income tax brackets for 2023 tax returns.

The IRS has also published tax brackets for 2024 tax returns (which will be filed in 2025). The IRS adjusts tax brackets on an annual basis to prevent "bracket creep," which occurs when inflation increases income and pushes individuals into higher tax brackets or reduces the value of tax deductions and credits. This can result in taxpayers paying a higher proportion of their income taxes over time, even if their real purchasing power hasn't increased.

Here are the federal income tax brackets for 2024 tax returns (for the 2025 tax season).

To calculate your tax bracket for the 2024 tax season, click here.

Capital gains tax is a tax on the profit earned from the sale of capital assets such as stocks, real estate, bonds, and other investments. Capital assets can be short-term (held for one year or less) or long-term (held for more than one year). Short-term capital gains are generally taxed at your income rate, while long-term capital gains have their own ax rates that are based on your income level.

Likewise, divided tax is a tax on the income received from owning shares of stock in a corporation or mutual fund. Dividends can be classified as qualified or non-qualified. Qualified dividends are generally taxed at the same rates as long-term capital gains, while non-qualified dividends are typically taxed at ordinary income tax rates.

Below are the 2023 and 2024 tax rates for long-term capital gains and qualified dividends.

The general rule of thumb is to keep your federal and state tax records for at least 3 years from the date you filed the return. This 3-year period is the IRS's time limit for auditing your tax returns.

In some instances, the IRS has a longer time limit for deciding whether to audit your returns. For example, if you underreported your income by more than 25%, it is recommended that you keep your tax records for 6 years. Business tax records should be retained for at least 7 years, and some records may need to be kept longer if they involve assets or transactions that span multiple years.

Some records should be kept indefinitely or for a more extended time period:

• Records related to the purchase, sale, or improvement of property should be kept until you sell the asset and report the transaction on your tax return. This can help calculate capital gains or losses accurately.
• Records related to retirement account contributions and withdrawals should be kept as long as you have the account.
• Inheritance and gift records may need to be kept indefinitely, as they can have tax implications.

Tax deductions and tax credits can help reduce the amount of income tax you owe. However, they work in different ways and have distinct characteristics.

A tax deduction reduces your taxable income. Deductions are subtracted from your gross income to arrive at your taxable income. Conversely, tax credits directly reduce the amount of income tax you owe, dollar for dollar. Tax credits are applied after your tax liability has been calculated based on your taxable income.

Tax deductions are classified as either "above-the-line" or "below-the-line."

Above-the-line deductions are subtracted from your gross income before calculating your adjusted gross income (AGI). They are available to all taxpayers, regardless of whether you itemize deductions or take the standard deduction (discussed later). Examples of above-the-line deductions that high income earners may want to consider include contributions to retirement accounts, student loan interest, and health savings account (HSA) contributions.

Below-the-line deductions are itemized deductions, which you can claim if they exceed the standard deduction amount. Common itemized deductions include mortgage interest, state and local taxes, medical expenses exceeding 7.5% of your AGI, and charitable contributions.

Deciding between taking the standard deduction or itemizing your deductions is a big consideration in tax planning, and your choice depends on which one provides a greater tax benefit to your financial situation.

The standard deduction is a fixed dollar amount that reduces your taxable income without requiring you to provide documentation on specific expenses or deductions. The standard deduction is convenient and simple to use, making it a popular choice for taxpayers with straightforward financial situations -- you don't need to keep detailed records of specific expenses to claim it.

The standard deduction is determined by your filing status. For the 2024 tax season, the 2023 standard deductions for single filers and married filing jointly are $13,850 and $27,700, respectively. For the 2025 tax season, the 2024 standard deductions for single filers and married filing jointly are $14,600 and $29,200, respectively.

Conversely, itemizing deductions involves listing and providing documentation of specific expenses and deductions on your tax return. It requires more time and effort due to maintaining records, but it is often more beneficial if your total eligible deductions exceed the standard deduction for your filing status.

When it comes to taxes, most people want to reduce the total amount that they're required to pay. Fortunately, there are a variety of tax planning strategies high income earners can use to reduce their tax liability for both the short-term and long-term.

Income Deferral

Income deferral is a tax planning strategy used to postpone the recognition of income until a later tax year, often when you expect to be in a lower tax bracket or when it's more advantageous to report the income. This can help reduce your current-year tax liability. Some common ways to defer income include:

• Contributing to tax-advantaged retirement accounts
• Deferring exercising or selling stock options
• Structuring the sale of property or an asset as an installment sale, which allows you to recognize the income in multiple. years as you receive payments from the buyer

Income Acceleration

Income acceleration is used to recognize income in the current tax year rather than deferring it to a later year. This strategy can be employed when you expect to be in a lower tax bracket this year compared to future years or when certain deductions or credits are more beneficial in the current year. Accelerating income can increase your current-year tax liability but may reduce your overall tax liability when combined with other tax planning strategies.

Adjust the Assets in Your Portfolio

Employing strategies that can change the character of your income can change how your income is taxed in future years. Here are some adjustments to consider:

• Convert your Traditional IRA or 401(k) to a Roth IRA. You contribute after-tax dollars to a Roth IRA, which means you won't receive a tax deduction for your contributions in the year you make them. However, once your money is in a Roth, it can grow tax-free over time. Any interest, dividends, or capital gains earned within the account are not subject to annual taxation. Once you reach age 59 and a half, you can start making qualified withdrawals from your Roth that are entirely tax-free.
• Consider purchasing tax-exempt bonds. Tax-exempt bonds, also knowns as municipal bonds or muni bonds, are debt securities issued by state, local, or municipal governments and certain government agencies to raise funds for various public projects and infrastructure improvements. These bonds are considered tax-exempt because the interest income they generate is exempt from federal income taxes and, in many cases, state and local income taxes as well.
• Take advantage of your HSA, if available. Investing HSA contributions can be a smart way to grow your HSA funds over time, potentially providing you with more money to cover future medical expenses while also enjoying tax advantages. Many HSA providers allow for investments and include investment options such as mutual funds and exchange-traded funds (ETFs). You can typically choose to allocate a portion of your contributions to investments while leaving the rest in a cash account for immediate medical expenses. Contributions to HSAs are tax-free, and qualified withdrawals for eligible medical expenses are tax-free.
• Add Tax-Efficient Mutual Funds and ETFs to your portfolio. ETFs are known for their tax efficiency because they are structured in a way that allows investors to minimize capital gains distributions. They also have lower turnover compared to actively managed mutual funds, which generally leads to fewer capital gains distributions and can help you defer taxes. Similarly, some mutual funds are specifically designed as "tax-managed" funds, with the goal of minimizing capital gains distributions and providing tax efficiency. These funds aim to manage their portfolios in a way that generates fewer taxable events. Consider holding investments in mutual funds and ETFs for the long term to take advantage of lower tax rates on capital gains.
• Employ tax-loss harvesting. Tax-loss harvesting is a tax planning strategy designed to minimize your overall tax liability by strategically selling investments that have experienced capital losses and offsetting capital gains. By realizing losses, you can reduce your taxable income and lower your tax bill. If your capital losses exceed your gains, you can use the excess loss to offset other types of income, such as ordinary income, up to certain limits ($3,000 for individuals, $1,500 for married individuals filing separately). Also, if your total capital losses exceed your total capital gains for the year, you can carry forward the excess losses to future tax years. These losses can be used to offset gains in future years.

The tax planning strategies you choose to employ can vary based on your financial situation, and it's important to consult with a financial advisor or tax professional to understand the implications of each of these strategies. If you'd like to learn more about tax planning strategies available to you, you can reach out to your advisor. Or, if you're interested in working with Chicago Partners to devise a tax planning strategy or tax preparation for 2024, you can send us a message here.