Alan Clopine
Written By

Alan Clopine is the Executive Chairman of Pure Financial Advisors, LLC (Pure). He has been an executive leader of the Company for over a decade, including CFO, CEO, and Chairman. Alan joined the firm in 2008, about one year after it was established. In his tenure at Pure, the firm has grown from approximately $50 [...]

Published On
October 6, 2014

Updated March 7, 2018

Imagine that you receive a big windfall this year from a financial transaction. Perhaps you will sell a property at a big gain, exercise stock options, sell your business, receive a large bonus, collect a large severance payout, achieve record sales in your business or any number of financial windfalls. You will probably get very excited until you think about your federal and state income tax liability. A large income event, when living in a high-tax state (such as California), can be taxed at a 50% or more.

Naturally, if you find yourself in such a situation, you will want to take advantage of as many tax reduction strategies as possible. Listen to George Sutherland, Supreme Court Associate Justice from 1922 through 1938, “The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted”.

There are literally hundreds of tax strategies that can be utilized separately or in conjunction with each other. This article will address some of the more common tax strategies for high income earners:

Employee 401(k) & 403(b) Contributions:

If your employer offers a 401(k) or 403(b) plan, you can elect to withhold $18,500 from your paycheck in 2018, or $24,500 if you’re over 50 years old. These contributions reduce your taxable salary, which will reduce your income taxes.

Municipal Interest:

If you have significant taxable interest income, you may want to switch some or all of your interest-bearing accounts to municipal interest. If you purchase a municipal bond (or bond fund), from your own state, you will pay no federal or state taxes.

Dividend Income:

Qualifying dividends (see IRS Publication 17) are taxed at capital gain rates while non-qualified dividends are taxed at the higher ordinary income tax rates. Make sure you receive qualified dividends to ensure the lower capital gain rate.

Harvesting Capital Losses:

If you have large capital gains this year, consider selling positions in your portfolio that would result in losses. Those losses will offset “dollar for dollar” against other capital gains. You must wait 31 days to repurchase the same investment or you can purchase a similar (but different) investment immediately.

VIDEO: Breakdown of the Tax Cuts and Jobs Act of 2017

Self-Employed Business:

Perhaps you want to start a side business at some point in the future. This might be a great year to begin because of the many potential business deductions available to self-employed business owners.

Rental Real Estate:

If you own rental real estate, you may be discouraged (from a tax standpoint) because you’re not able to currently deduct your losses. Perhaps you (or your spouse) should consider the “Real Estate Professional Status” designation by the IRS which lets you deduct all your real estate losses without regard to the passive loss rules (see IRS Publication 925). Note: California does not conform to this law.

Self-Employed Retirement Plans:

As a business owner, you may set up your own pension plan including a SIMPLE, SEP, Solo-401(k), Safe-Harbor 401(k), Profit Sharing Plan, and Defined Benefit Plan. The tax deductions can be significant but remember that you will need to offer the pension plan to all qualifying employees.

Charitable Contributions:

When you donate appreciated property (i.e. stock with unrealized gains), you get a charitable tax deduction for the fair market value of the property. You do not pay any tax on the gain. This type of contribution is limited to 30% of your adjusted gross income. b. Can you take a tax deduction today for future year’s contributions? The answer is yes, by opening up a “Donor Advised Fund”. You get an immediate tax deduction and the ability to designate charities to receive the funds in future years.

Don’t Forget the Little Stuff:

The tax legislation taking effect 2018 has many changes that could affect your overall tax due. Not the least of which are changes to adjustments and deductions. While miscellaneous itemized deductions are no longer available and certain others such as home mortgage have new limitations, there are still many adjustments and deductions to consider such as your contributions to deferred retirement accounts or HSA plans, for example, and the solar tax credit, which is still available at the time of this writing. Even if you don’t have substantial deductions, you may benefit from the increased standard deduction.

It’s important to utilize all appropriate tax strategies when you encounter high income years. Why pay any more to the government than is absolutely necessary? If you are expecting a high income year, please see your CPA or financial planner before the year is over. Most of these tax reduction strategies need to be implemented during the tax year.

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