High-income taxpayers pay the most tax, so they have the most to gain from taking advantage of lucrative tax breaks. Using favorable tax provisions can save those making $100,000 or more a huge amount at tax time.
Many tax breaks are designed for low- and middle-income Americans to take full advantage, and phase-out provisions prevent those with higher incomes from using them. However, the following tax breaks are available to taxpayers earning $100,000 or more, and they can cut your tax bill more than you might expect.
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Contributing to your 401(k) at work
For most people, the biggest potential reduction in your taxable income comes from making contributions to a 401(k) or other employer-sponsored retirement plan. For 2016, you can set aside $18,000 in a 401(k) if you're younger than age 50, and $24,000 if you're 50 or older. The higher your income, the greater the value of setting that money aside on a tax-deferred basis, because the money that you're sheltering from current taxation would ordinarily get taxed at a higher tax bracket you're your lower-income counterparts would pay.
Sometimes, the anti-discrimination provisions of 401(k) law prevent wealthy workers from contributing the maximum. Average contributions among those considered highly compensated employees can't exceed the overall average contributions by more than a set amount, and so if other workers don't participate enough, then those seeking to max out their 401(k)s might not be able to do so. Most 401(k)s pass the anti-discrimination tests, but they're still a trap that can affect some highly compensated workers.
Home-related deductions
Everyone's allowed to itemize mortgage interest and state and local real-estate taxes, but the value of those deductions is higher for upper-income taxpayers. Again, deductions reduce tax liability according to what tax bracket you're in, so the value of a deduction is greater for someone paying tax at 35% or 39.6% than for someone in the 15% or 25% marginal tax bracket. Moreover, high-income individuals tend to buy pricier residences that generate more in interest and taxes, and that's more likely to push them above the standard deduction amount than a middle-income taxpayer.
There is one check on these and other itemized deductions. Those with incomes above $250,000 to $300,000 depending on filing status can have their itemized deductions phased out, with the potential to lose up to 80% of your qualifying deductions. The phaseout takes away itemized deductions equal to 3% of excess income over the threshold, subject to the 80% maximum reduction. Even with these reductions, however, the value of home-related itemized deductions can be huge for upper-income taxpayers.
Low rates on dividends and long-term capital gains
Investors get special tax breaks that have disproportionate value to high income taxpayers. Qualified dividends and long-term capital gains get preferential treatment, with maximum tax rates that are far lower than the regular income tax rates.
In particular, those in the 25% to 35% tax brackets pay a maximum of 15% on capital gains on assets held longer than a year and on dividend income. A higher 20% tax rate applies to those in the 39.6% bracket. As you can see, middle-class taxpayers in the 25% tax bracket save just 10 percentage points of tax with this provision, but upper-class taxpayers in the 28%, 33%, and 35% brackets save 13 to 20 percentage points. Top-bracket taxpayers do almost as well with a 19.6 percentage point break. And because wealthy taxpayers are more likely to invest, it's easier for them to get income in this low-tax category.
If you make $100,000 or more, you probably already pay a lot of tax. Taking advantage of these provisions can help you reduce what you'll send to the IRS and keep more of your hard-earned money for yourself.
