By: Arron Bennett, CEO — Bennett Financials
As we enter tax season, what has to be paid and how to save on taxes will be on everyone’s mind. High-income earners — which the IRS defines as anyone making over $200,000 a year — often find themselves overpaying on taxes, and this common pitfall of business owners and other professionals has a range of causes, from misunderstanding complex tax codes to only taking standard deductions.
As high earners sit down to sift through 2024’s taxes, there are several factors they should consider that could help them pay less. By considering the primary reasons for overpayment and developing sound strategies to ensure they’re not leaving money on the table, high earners can potentially save thousands and learn a more efficient and effective way to file.
This article will explore the common reasons that high earners overpay their taxes, key areas where they miss out on tax savings, and strategies for maximizing their savings and improving their financial position in the future.
How Do High Earners Overpay?
Several factors can cause high earners to overpay their annual taxes. People are often accustomed to filing their taxes the same way, so they stick to the status quo even if they earn more money. If one finds themselves in a better financial position, it may benefit them to sit down with a tax expert and discuss any changes that may need to be made to how they file, handle withholdings, take deductions, or handle their strategic financial planning.
A primary reason why many high earners are paying too much is that they continue to opt for standard deductions, such as 401K contributions or business expenses. High earners could be eligible for various other deductions, such as retirement account contributions, investment-related deductions, or charitable giving deductions.
In addition, some decisions top earners make regarding withholding or estimated tax payments could cause them to pay more than necessary. People with variable incomes — such as entrepreneurs — may over-withhold to avoid an unexpected tax bill or overpay rather than risk scrutiny from the IRS or the dreaded audit.
A complicated tax code can also cost high-earning taxpayers if they are not careful. High-income earners could be beholden to extra taxes, such as net investment income tax (NIIT) or additional Medicare taxes.
When it comes down to it, many people may overpay without realizing it because they simply do not have the time or tax knowledge to optimize their tax strategies. However, many high earners may discover that they cannot afford to be too busy to strategize or educate themselves on ways to save money.
Reduce Your Tax Burden
Many high earners have already caught on to the litany of ways to reduce their tax burden and contribute to long-term wealth building. The tax savings strategies below should be discussed with your chosen tax expert, but could easily save top earners thousands each year.
Creating a Trust
Depending on what type of trust you create and the structure of that trust, you can reduce your tax burden. For example, funds transferred to an irrevocable trust are removed from your taxable estate, reducing estate taxes. Dynasty trusts allow you to pass wealth down to the next generation without transfer taxes, which is how many people create generational wealth.
Create a Holding Company
When you create a holding company as part of a financial planning strategy, you can pass assets between the holding company and subsidiary companies free of tax burden. You may also be able to file consolidated tax returns depending on how much of a subsidiary company the holding company owns. Holding companies also allow for more strategic profit distribution, letting you decide how and when taxes are paid.
Maximize Retirement Contributions
When you put the maximum amount you can into a retirement account, you are reducing the amount of income that is subject to taxes. For each dollar you contribute to your retirement account, you receive a dollar-to-dollar deduction and have the added bonus of being more prepared to live well in retirement.
Maximize Individual Deductions
While taking the standard deduction works best for most people, high earners may want to consider taking individual deductions. By itemizing deductions, top earners can write off medical and dental expenses, state and local taxes up to $10,000, mortgage interest, charity contributions, and a host of other available deduction options. A tax expert can help one review their finances with a fine-tooth comb to determine whether individualized deductions can save them more money in the long run.
Playing “defense” instead of strategic financial planning about taxes can cost high earners thousands in the long run. Taxes can be complicated, and this combination of complex tax laws and a lack of strategic planning can hurt top earners. However, with intentional planning at tax time and the help of a competent tax expert, high earners can take advantage of the legal tax breaks that will allow them to reduce their tax burden and build generational wealth.
— Arron Bennett founded Bennett Financials with a mission: to transform the accounting industry by shifting from reactive tax preparation to proactive financial strategy that empowers business growth. Bennett provides sophisticated financial leadership that has helped small businesses find over $65 million in taxes to date. His fractional CFO approach delivers strategic financial expertise that accelerates growth and maximizes profitability, resulting in multiple clients achieving significant valuation exits.
Disclaimer: This article is for informational purposes only and does not constitute financial or tax advice. The strategies discussed may not be suitable for all individuals, and readers are encouraged to consult with a qualified tax professional or financial advisor to tailor these strategies to their specific circumstances. The information presented is based on general tax principles and may not reflect the latest changes in tax laws.
Published by Joseph T.