If you earn a lot of income, you're used to paying a lot of tax. But it's true that the tax breaks that are available to wealthy taxpayers can produce huge savings. Taking advantage of them will help offset the higher taxes that you pay under a progressive tax system -- and it'll avoid leaving money on the table that could otherwise go toward boosting your savings.
Lawmakers have designed many tax deduction and credits to go only to those who truly need them, setting income limits that prevent wealthy taxpayers from using them. However, the following three tax breaks don't have any income limits associated with them, and they can be especially valuable to rich taxpayers.
1. Be business-savvy with your taxes
Many rich taxpayers are entrepreneurs who were able to create a successful business. Tax reform has been especially kind to business owners, in that it created some new tax breaks that apply only to businesses.
If your business is set up as a traditional corporation, then you might benefit from the lower corporate tax rates that started applying to corporate income in 2018. Old law had rates that went as high as 35%, but the new rate structure imposes a flat 21% tax rate on corporations. That's had a huge impact on tax burdens for high-income businesses, and it could make a big difference to your tax bill.
However, you don't have to have a corporation in order to benefit from tax reform. Businesses that are set up as partnerships, limited liability companies, or sole proprietorships are now able to take advantage of what's known as the pass-through tax deduction to reduce their taxable income. A tax break of up to 20% of your business income is available to many business owners, leading to dramatic savings.
In some cases, it might make sense to look at switching the type of business you use, with the goal of saving in overall taxes. It all depends on exactly how much money your business earns as well as whether you have outside employees and what other expenses you claim as tax deductions, but it's worth looking closely at your tax picture with your advisor to come up with a tailor-made strategy.
2. Don't skimp on your 401(k)
The 401(k) has some of the highest contribution limits of any retirement plan, and they're on the rise again in 2019. Last year, limits of $18,500 for those younger than 50 and $24,500 for those 50 or older applied to 401(k) participants. In 2019, those numbers each go up by $500. As long as your company is able to meet the anti-discrimination requirements, then you'll be allowed to contribute up to the maximum regardless of how much money you earn. If you're 50 or older and save the $25,000 maximum, then you could produce tax savings of as much as $9,250 if you're in the top 37% bracket.
Business owners can set up their own special 401(k) or other retirement plans that let them save even more. For 2019, a business owner younger than 50 can save a combined $56,000 in employer and employee contributions to a 401(k). That number jumps to $62,000 for those 50 or older. With more sophisticated plans, you might be able to set aside even more on a tax-deferred basis, but these amounts are available without too many complications.
3. Make the most of dividends, long-term capital gains, and tax-exempt interest
Investors know that the tax laws often favor investment income over work income. For instance, most interest on state and local debt obligations, also known as municipal bonds, is completely free of federal income tax. That's of only minimal value to a taxpayer in the low 10% or 12% bracket, but for a top-bracket taxpayer paying a 37% rate, the exemption for municipal bond interest can be extremely valuable.
Other breaks offer lower tax rates. For example, if you have income from qualified dividends or long-term capital gains, then lower maximum tax rates apply depending on your overall income level. For the wealthy, the top rate on these dividends and capital gains is 20% -- meaning that you'll pay just over half the tax that you'd pay on a similar amount of salary or wages.
Save what you can
If you're rich, you probably pay a ton of taxes. By using these breaks, you won't be able to avoid taxes entirely, but you will cut the amount you have to pay the IRS in the next few months.