As tax season gets underway, high-earning individuals search for ways to limit their exposure and reduce their taxable income. Some of the ways of doing so — like underreporting earnings or improperly writing off business deductions — are ethically questionable at best and illegal at worst. However, there’s no need to risk the attention of the IRS if you want to reduce your taxable income.
High-earning taxpayers have a few options for minimizing their tax exposure and even generating long-term financial benefits. Here, we’ll explore three of the more effective, totally legal strategies that can help lower your tax bill on April 15.
Open an HSA
One of the most powerful savings vehicles that high-earning workers have for capping their taxable income is a health savings account (HSA). Available to those with high-deductible health plans, an HSA can offer a triple tax advantage. Contributions to an HSA are tax-deductible, and its investments can provide tax-free growth. Withdrawn funds for approved medical expenses are not taxed.
Unlike other flexible spending accounts (FSAs), the funds in an HSA roll over every year. You’ll never lose them, even if your employment situation changes. Most other FSAs have a “use-it-or-lose-it” requirement — you must spend the money before the end of the year. But as long as you spend HSA funds on approved medical or health expenses, your contributions stay intact.
The 2024 maximum contribution limits to HSAs are $4,150 for individuals, $8,300 for families, and an additional $1,000 in make-up payments for those over 55 years of age. If you haven’t yet maxed out your HSA contributions for last year, you can do so between now and April 15 and still have the funds applied to your 2024 limits. (You can also start 2025 contributions anytime.)
Funds in an HSA cover a broad range of qualified medical expenses. These can include copays and deductibles, prescriptions, treatments, dental and vision care, and medical supplies or equipment. You can reduce your taxable income while taking proper care of your family’s health.
Fund a 529 Plan
It’s getting more expensive by the year to fund a college education. In the 2024-25 tuition year, the average annual costs for an in-state public college work out to about $24,030. Private four-year colleges can cost more than double that amount. But if you start early, you may be able to get some tax help by opening a 529 plan for your children, grandchildren, or other benefactors.
A 529 plan is an investment vehicle specifically aimed at saving for college. The tax advantages the plan offers vary from state to state, although contributions are not federally deductible. However, the most common benefits are tax-free investment growth and withdrawals for approved education expenses.
Contributions to a 529 fund aren’t subject to annual limits and can count as gifts toward estate tax purposes. The IRS even allows you to make a lump-sum gift of $95,000 to a 529 fund — you can spread this out across five years without incurring a gift tax. The fund can also generate earnings in the form of compound interest.
Consider Tax Residency Planning
Although all Americans are subject to federal taxation, residents in certain U.S. states enjoy more favorable tax statuses than others.
A handful of states — notably Florida, Nevada, Texas, Tennessee, and a few others — do not charge state income tax on wages or retirement income. Wyoming, Florida, and Nevada also have low or more moderate property taxes.
To take advantage of these states’ relaxed tax rules, new residents must establish their new state as their “domicile,” or where they intend to live permanently. Alternatively, they can be considered a “statutory resident” if they stay at least half of the year in the same place. Residents must take certain actions to back up their domicile status, like registering to vote or obtaining a state driver’s license.
Keep in mind that although some states offer total relief from income tax, they may impose property and estate taxes on individuals.
Consult With a Professional
At Zabel & Co., we can help you find legitimate, legal ways to reduce your taxable income. To learn more or schedule a free consultation, get in touch with us using our online contact form.