Wealthy Americans often pay a lot of tax, but they also have access to some lucrative tax breaks. By having more financial resources to take advantage of favorable tax provisions and by being in higher tax brackets that make potential write-offs worth more in tax savings, wealthy taxpayers have a lot to gain from smart tax planning.
Many tax breaks have income limits that prevent the wealthiest taxpayers from taking advantage of them. However, there are some deductions, credits, and other favorable tax laws that anyone can use to their advantage, even the best-off among Americans. Below are three things that any wealthy taxpayer should keep in mind in fighting to keep their tax bills low.
1. Use employer retirement plans to the utmost
The same contribution limits for 401(k) and similar employer-sponsored retirement plans exist no matter how much income you make, with limits of $18,500 for those under 50 years old and $24,500 for those 50 or older in 2018. As long as your company passes tests that require enough non-highly compensated employees to participate in a 401(k) plan, then you'll typically be able to contribute the maximum. If you contribute to the traditional account within your 401(k) rather than a Roth option, then you can exclude your contributions from income, saving taxes at rates of as much as 37% in 2018.
Wealthy taxpayers who own their own businesses can save even more by using business retirement plans, combining employer and employee contributions. The overall limit for total employer and employee contributions in 2018 is $55,000 for those under 50 or $61,000 for those 50 or older for regular defined contribution plans. Specialized defined benefit plans can help you defer even more income to reduce taxes even further in some cases.
2. Pay less or no tax on tax-favored investments
The tax laws offer lower rates on certain types of investment income. Some categories offer lower rates, while a few charge no tax at all.
If you earn dividend income that meets the tests for qualified dividends in a taxable account, then you'll pay a lower tax rate. Most of those in the 10% and 12% brackets won't pay any tax at all on their qualified dividends, while the majority of those in higher brackets will pay 15%. A 20% maximum rate applies to those who would have been in the highest tax bracket under previous tax law, although with the way the new brackets work out, a portion of the 35% bracket will also get clipped with the highest 20% qualified dividend rate.
Also qualifying for lower tax rates are capital gains on investments held for longer than a year. Any net gain gets taxed at the same reduced rates as qualified dividends.
Finally, interest on obligations of state and local governments is generally untaxed at the federal level. This makes municipal bonds extremely favorable from a tax standpoint, although the yields that these debt instruments offer are usually lower than those on comparable taxable bonds in order to account for their different tax treatment. For the wealthiest investors, avoiding 37% tax can be worth accepting a lower yield.
3. Make the most of your business
Many wealthy taxpayers made their money by creating their own businesses, and the new tax reform provisions have a few advantages over previous tax law. For those who structure their businesses as corporations, lower tax rates of 21% replace the old 35% rates that applied in 2017, making it less of a burden to pay taxes at the corporate level. Meanwhile, those who structure their businesses as sole proprietorships, partnerships, or LLCs will have the ability to use new pass-through deductions to their advantage.
Which business structure makes the most sense for you depends on a variety of factors, including the amount of money you make and the types of offsetting expenses and other deductions your business can claim. In some cases, it might be smart to look at potentially changing your business form to take advantage of favorable tax law changes more fully.
No one likes to pay tax, and those who make $100,000 or more pay a lot of it. By using these breaks, you can ease the pain and write out a smaller check to the IRS next spring.