Now that you’ve made it into a higher income bracket, it’s a great time to review the best methods you can use to preserve your primary and supplemental sources of income. The top long-term tax strategies for high-income earners should be integrated into a comprehensive wealth management plan which is subject to adjustments throughout your lifetime. Tax planning begins with understanding what it means to achieve an ideal state of financial health. It’s also important to become familiar with what options are broadly available so that you can then decide which ones are best suited to your needs. If you gather critical information early on, and hire professional resources, you can then make cornerstone decisions that will result in tax conscious benefits that will last not just for years, but your entire lifetime.
1. Strong Long-Term Tax Strategies Start With Good Documentation
It may feel like a tedious task, but getting into the habit of correctly categorizing and storing various types of documents is foundational to planning your tax strategy. The more materials you have access to, the better your reference data will be when the time comes to file your taxes. Most notably, proper documentation raises awareness to new ways you can preserve your income. Here are some general examples of items you need to track:
- Work-related meal and entertainment expenses
- Work-related travel and lodging
- Non-commuting transportation
- Business-related general office needs
- Clothing items such as uniforms (not suitable for personal use)
These are daily, impromptu expenses that you can easily overlook, but you will notice these high-frequency items quickly add up once to start tracking them. The most common obstacle to documenting small expenses is time. Your time is valuable. Fortunately, low-cost, easy-to-use mobile apps are available that allow you to scan, categorize, and calculate totals of receipts as you go. If you have employees, find one that enables you to create groups to help keep everything in one place.
What the IRS Says About Your Documentation
The IRS wants you to keep records for three years from the date you initially filed your last year’s tax return. If you choose to pay your taxes on quarterly business earnings, then you need to track a rolling quarterly record of income, related expenses, and deductions. When you owe taxes, you are required to keep records for two years from the date of payment. The 7-year paper storage scenario only applies in situations where someone has made an improper debt reduction or in the event of business losses and failed investments, so look into using cloud storage. Maintain your physical records as required, but then back up those financial statements, invoices, and receivables in the cloud for extended periods as part of your contingency plan.
2. Consider SEP-IRAs
With so much talk about 401(k)s, Traditional IRAs, Roth IRAs, and even Roth 401(k)s, you may have started to tune some of the information out. However, you want to listen up if you hear mention of SEP-IRAs, which is an acronym for “Simplified Employee Pension – Individual Retirement Arrangements.”
SEP-IRAs are ideal for smaller companies that want to offer a retirement savings option for their employees without making the commitment to hire a retirement services consultant and becoming a permanent plan sponsor. The IRS provides a guide on how to properly notify your employees of the plan. While only employers can contribute for their employees, self-employed individuals can contribute up to 25% of their earnings. However, the government restricts the percentage of income business owners can contribute to their SEP-IRAs versus what they add to their employees’. High income earning self-employed individuals can save 25% of their net earnings, or up to $55,000 a year as of 2018, and the cap increases each year. It’s easy to check what the current allowance is.
Making continuous contributions to your SEP-IRA retirement portfolio significantly reduces present-day taxable income, and your retirement contributions and earnings and money market savings aren’t taxed until you begin making withdrawals when you retire. Even better, these accounts may allow for a greater variety of investments than traditional retirement accounts. How much and how often you contribute each year is up to you. SEP-IRAs are easy to set-up at a bank or other financial services company.
In some cases, better alternative plans for your situation may be a 401(k) or a Solo 401(k).
3. Plan Strategically With Tax-Loss Harvesting
If you have a sizable investment portfolio, then you can plan for losses and reduce tax liability on capital gains simultaneously using tax-loss harvesting as a strategy. It is one of the more complex long-term tax strategies for high-income earners because it also involves the precise timing of buying and selling shares of stocks, mutual funds, bonds, and other tradable funds.
The first step is choosing whether to apply your tax losses on short-term or long-term investments. Short-term investments get taxed at a higher rate, but if some of your investments have lost value, then you can factor in those losses as a deduction against your total tax bill. Most mutual funds pay short-term capital gains as an additional dividend in November or December.
Long-held investments get taxed at a much lower rate than short-term investments, which the IRS treats as ordinary income. The effective tax rate depends on your income bracket. Long-term annual dividend payments are generally taxed lower than short-term distributions.
Near-term & Extended Tax Losses
Short-term and long-term tax loss strategies work best in tandem. Unused capital losses can be carried forward into next year’s tax file, reducing taxes on future capital gains even when you don’t reap the tax benefit from the entirety of your market losses in the current year. When properly applied, you can save money by reducing taxes owed now and in the future.
Before making any strategic sales to minimize the impact of financial losses or to reduce capital gains taxes, your advisor must understand your overall wealth management goals. When you prepare to divest from a fund, that decision should also coincide with a decision to reinvest capital in investment vehicles which will maintain your current investment mix and strategic target allocation.
For tax purposes, wash sales should be avoided. Any loss on the sale of stock that is repurposed 30 days or less before or after the sale will be disallowed as a wash sale. You are not allowed to reinvest in the same stock ticker. You can reinvest in a similar sub-asset class after the 30-day waiting period. The bank custodian will record the sales at-cost in a well-administered brokerage account.
The Best Tax Strategy is Personalized to You
These are just three long-term tax strategies for high-income earners. To help you navigate these options, and more, it’s essential to find the right tax and wealth professionals who can help you determine which strategies will work best for your individual financial situation.
SD Mayer is a well-equipped and responsive team of professionals who are dedicated to you reaching your financial goals. With a holistic approach to wealth management, we draw on our decades of advisory experience to serve the Bay Area community that we live in and love. If you are ready to begin exploring long-term tax strategies to help you reach your goals, contact us today.
SECURITIES AND ADVISORY DISCLOSURE:
Securities offered through Valmark Securities, Inc. Member FINRA, SIPC. Fee based planning offered through SDM Advisors, LLC. Third party money management offered through Valmark Advisers, Inc a SEC registered investment advisor. 130 Springside Drive, Suite 300, Akron, Ohio 44333-2431. 1-800-765-5201. SDM Advisors, LLC is a separate entity from Valmark Securities Inc. and Valmark Advisers, Inc.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. The services of an appropriate professional should be sought regarding your individual situation.
The examples given are hypothetical and for illustrative purposes only.