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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?

Estate Planning, Investing, Bonds / Fixed Income, Real Estate, Taxes
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August 2018

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.



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