There are plenty of well-known tax deductions and credits that favor lower-income individuals and families, such as the deduction for student loan interest and the Earned Income Tax Credit. However, there are also a handful of tax breaks that can benefit those on the other end of the spectrum. We asked three of our contributing writers to discuss some of the best tax deductions available that can help high-income Americans trim their payments to the IRS. Here's what they had to say.
Dan Caplinger: One of the most lucrative deductions that wealthy taxpayers can take advantage of comes from making donations of appreciated stock to charity. The provision is a rare instance where the tax laws essentially allow you to get a double benefit from the same strategy.
Here's how it works: say you own a stock that has doubled in value over the past two years and your position is now worth $10,000. If you were to sell that stock and then give the proceeds to charity, you'd owe capital-gains tax on the $5,000 profit, costing you $1,000 in tax if you pay the highest long-term capital-gains rate of 20%. That would leave you $9,000 in net proceeds to give to charity, and assuming you can itemize and are in the top tax bracket of 39.6%, you'd have a tax deduction worth about $3,600. Taking the deduction and subtracting the tax liability, you'd have a net tax break of $2,600.
What the appreciated-stock provisions allow you to do is to give your stock directly to charity. By doing so, you avoid the $1,000 in capital-gains tax entirely, and you're given credit for a deduction for the full $10,000 value of the stock. That gives you a tax break approaching $4,000. Moreover, the charity can sell the stock, and because it's a tax-exempt entity, it doesn't have to pay taxes on the gains either. For the rich, there's no better way to save taxes and do good at the same time.
John Maxfield: The mortgage interest deduction seems like the last tax deduction rich people would benefit from. We are, after all, talking about rich people; and rich people can presumably own their home outright. But here's the thing: if you have both a big income and a big house, then encumbering the latter with a mortgage could be a smart move.
Let's say, for example, that you have a $1 million mortgage -- this is the largest mortgage you can have under the mortgage interest deduction. At current interest rates, over the first year of the loan, you will have paid roughly $38,000 in deductible interest expense.
Assuming you're in the highest tax bracket, this will reduce your income tax liability by approximately $15,000 in the first year. This brings the cost of your mortgage down to only $23,000, or 2.3% on an annualized basis. Consequently, all you need is an investment that yields slightly more than 2.3% in a typical year, or less than half the market's long-run average, to come out ahead.
Matt Frankel: One great way to cut your tax bill and set yourself up for the future is to maximize your tax-advantaged retirement savings. And, high-income earners may be able to set aside more than you may think.
Through a traditional IRA, you can set aside up to $5,500 per year ($6,500 if you're over 50), and depending on your employment situation, you may be able to deduct the contributions on your tax return. However, other savings vehicles offer significantly higher limits.
If you're an employee, your 401(k) or similar retirement plan allows for up to $18,000 in elective deferrals per year, or up to $24,000 if you're over 50. However, the overall limit including employer contributions is $53,000 ($59,000 including catch-up contributions). If you're a high-income employee, one smart tax strategy might be asking your employer to max out their contributions to your 401(k) instead of paying that money to you as salary. After all, $53,000 in 401(k) contributions can cut nearly $21,000 from your tax bill if you're in the highest income bracket.
If you own a business, there are several options available to you. You could set up a solo 401(k) which has the same $53,000 annual contribution limit as described above. Or, you could choose a SEP-IRA, which has an equally generous limit for high-income individuals.
Retirement savings is one of the best tax breaks available, since it has a double benefit. As we've seen, the tax deductions could save tens of thousands of dollars each year, and the benefits of tax-free compounding could mean millions over the course of your lifetime if you max out your savings.
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