What are some strategies to minimize the impact of taxes for high earners in a high-tax state?
My wife and I make $900,000 combined. We live in California, and pay a lot of taxes. Most of our income comes from our salaries and bonuses. We'd like to minimize the impact of taxes. What might be some good choices for us to consider? Tax-exempt bonds won't work, and tax-loss harvest has a marginal impact on our net income. Is real estate investing a good idea? What ideas should we consider?
First of all, I share your pain. My family and I live in the Bay area and are subject to an absurdly high cost of living and equally absurd CA tax rates. After deductions, you are most likely in the 11.3% CA marginal tax rate with a taxable income of $644,998 - $1MM. Although it's never prudent to paint with a wide brush when it comes to personal tax planning strategies, we go through this process with all of our clients in an effort to reduce taxable income during high earning years. After all, in your income range, every $1 reduction of taxable income is a tax savings of 48.3 cents. Some of these strategies may be beneficial to you, but it would require a thorough analysis of your specific circumstances in order to provide recommendations.
1) Max out your employer 401k plans. $18,500 if under 50. $24,500 if over 50.
2) If available, contribute to your HSA and/or FSA through work. Contributions are made on a pre-tax basis.
3) Tax location optimization- Different types of investments receive different tax treatment. Place less tax-efficient Investments such as fixed income in tax-deferred accounts and those that are tax efficient such as equities that receive preferential tax treatment in your individual, joint, or trust accounts. Studies show that location optimization can increase clients' after-tax returns anywhere from 10 to 50 basis points. Over time, this savings could be quite substantial.
4) Invest in real estate. There is a wide range of real estate investments available with different degrees of risk, liquidity, niches, and tax treatment. For some, annual distributions that are typically in the 6-7% range are mostly or completely offset by depreciation which can greatly decrease your tax liability. You are eventually required to recapture the depreciation when a liquidity event occurs. For some of our clients, we recommend 1031 exchanges into a new real estate company to further defer taxation. These typically require a holding period of 3-5 years.
5) If you're in CA and earn $900K, you may work in hi-tech and equity compensation is available to you. If so, take a proactive approach to managing your vested RSU's, ESPP, options, etc. If you are granted shares in a private company with a vesting schedule, consider filing an 83(b) form which may benefit you down the road.
6) If you are charitably inclined and have appreciated stock, consider gifting to a Donor Advised Fund ("DAF"). Not only do you avoid paying capital gains tax by selling the stock, the value of the shares when gifted is deductible on Schedule A of your tax return. You can choose when and to what organization to donate at any time, but the tax deduction is claimed in the year of contribution to the DAF. If your itemized deductions are close to the standard deduction, accelerating deductions such as charitable donations can be a very tax-efficient strategy.
This is by no means an exhaustive list, but a few ideas you may want to consider.
I hope this helps! Please let me know if you have any questions.
Let's begin with congratulations on the level of income you're making. It speaks well of where you come from. Having said that, it's difficult to recommend anything in a simplistic way that could be of assistance but let me throw a couple of things on the table that may be possible. First, let's assume you both are maxing out any 401(k) advantages through payroll deductions. Having said that, the next step would be to determine whether either of your employers would allow you to be treated as self-employed versus a salaried employee. If in fact this is the case, it's possible you could create a 401(k) solo plan for the self-employed individual and contribute well in excess of $50,000 year versus the maximum of 18,000+ for 401(k) plans. And depending on your ages, a "Defined Benefit Pension Plan"may offer substancially higher contributions and deductions if self-emloyeed. The next step would be determine whether either of your employers will allow you to defer some compensation. There's a very, very big caveat here. Even if the employer would allow for some deferred compensation which you would take in later years, you must understand that you become a "general" creditor of the business/Corporation. To put this in better perspective, if you work for General Motors, Apple or Google and had the option to use deferred compensation I probably wouldn't hesitate. However if you work for a closely held business that doesn't generate substantial profits, you have to think this out carefully because if the company were to file bankruptcy, you'd be at the very bottom of the creditor protection list. You raised the question of real estate and under normal circumstances, real estate may generate losses can be used to offset compensation. However, the level of your income would not allow you to take losses even if you had any losses as they would have to be carried forward until the property were sold at which time they can all be brought forward to reduce the capital gain. I hope this helps a little and good luck.
You are in a tough situation; assume you are maxing 401(k) plans pre-tax? HSA pre-tax? Depending on your age that is $45,000 to $57,000+ but hardly makes a dent. Assuming neither of you owns a business to derive the income above, the only thing left is oil/gas private placement investments and maybe historic tax credits to reduce state income taxes. Ask your CPA.
I’ve never written this on here, ever. I always give advice but in this situation I would be doing you a major disservice if I didn’t say it. May I beg you to please invest in a fee-only financial planner. It doesn’t have to be me.
Not an investment manager, not someone at the bank but a true planner that understands strategy not just insurance and investing.
Estate, tax, savings strategies and more can potentially be maximized by working with the right person.
I hate to be this way but with your income it’s worth the investment to find someone and have them guide you through all of this.
I can tell you about mega back door roths, others will gladly tell you to maximize insurance policies, etc.
It would be frivolous for any of us to tell you about these strategies and then say good luck with that. These things can go wrong so fast and cost you big time.
I wish you the best I just hope so badly that you consider looking. Napfa is a good resource and so is the XY Planning network. I’m in California and I’m happy to help you find a fit. Yes I’m a planner that loves finding a great new client that loves working with me but I also love helping find people good planners if they need it.
I wish you the best in your financial journey.
You are obviously in a great position for not only a very nice lifestyle, but to save for a fruitful retirement. The obvious challenge is you are both High-W2 earners where I imagine your bonuses are really causing quite the large tax issue, so with that being said, it is critical to cover the basics first and then to concern yourself with your future regarding retirement planning and taxation. You are correct about investment strategies that you have either tried or been giving advice on as bonds and tax-loss strategies are designed to reduce investment taxation not income tax relief. First thing, I hope you are both fully funding your 401ks to get the pre-tax benefit. Real estate investing will not solve your income tax issue because you get very little tax relief even if you owned the houses in a LLC. The taxes on flipping properties or income from rental properties will exasperate your issue. The high net-worth and high income clients that we work with we focus more on utilizing cash value insurance for future tax-free income. You can shovel a tremendous amount of money into this strategy that even though it is after-tax, the income will grow tax-deferred but you can draw from the account. All of those monies will provide income that will not be reported as income reducing your tax burden on social security and other IRA monies you have,. With regard to today's issue with reducing taxes, the first step is take your investments and utilize ETFs equities and bonds in addition to individual stocks because they are much more tax-efficient than mutual funds and individual bonds, while giving you the growth you will need.