Are you sure you’re doing all you can to squash your tax liability?

If you owed a significant tax amount this year, take the time to understand why. That way you can either take steps to reduce the bill or be prepared for it next year.

As a heads-up, W2 employees have fewer tax planning options, but that doesn't mean they have none. Here are 12 of the best tax planning moves to consider as a high-income W2 employee.

1. Max Out Your Pre-Tax 401(k)

Retirement accounts are great. They allow you to put away a ton of money for retirement, oftentimes with a matching contribution. You also have the choice between Roth (post-tax) and Traditional (pre-tax). 401(k)’s allow you to do up to $22,500 of your own contributions a year, then you can go above that with your employer match.

Roth 401(k)’s can be great for many reasons, but in your highest income earning years, it may make sense to defer this tax till later and reduce your taxable income today. Especially if you think you will be in a much lower tax bracket in the future.

Oftentimes it makes sense for highly compensated employees to max it out when they also can contribute elsewhere.

2. Use a Mega-Backdoor Roth

The Mega-Backdoor Roth is a great tool for high-income earners. You can still max out your pre-tax 401(k) and then contribute to an after-tax 401(k). The IRS rules allow you to contribute up to $66,000 a year, but everything beyond $22,500 is non-tax-deductible.

To do the Mega-Backdoor Roth (not all plans allow it), you put money into the after-tax 401(k), then roll it into either a Roth IRA or Roth 401(k). This can get complicated with many moving parts, so work with your financial planner before doing it. But this is an awesome way to get a ton of tax-free dollars put away for the future.

3. Individual Retirement Accounts

Once you have utilized your employer-sponsored retirement accounts to the right amount, it starts to make sense to look into individual retirement accounts like a Roth IRA. However, you may be thinking “well I can’t do that, my income is too high.” True… but there is something called the backdoor Roth IRA that allows anyone to utilize it. You simply put money into an IRA (you don’t deduct it), then you convert to Roth. It’s that simple, but make sure you do not have other pre-tax money inside a Traditional IRA, Sep IRA, etc.

You may be thinking “W would I want to pay tax today vs get the deferral when my income is so high?” Well, that is a good question. You most likely have already maxed out the other pre-tax options and now have post-tax dollars left. They can go here or to a taxable account. Never paying tax again is a great advantage you get with the backdoor Roth.

4. Utilize Other Pre-tax Options

Depending on what healthcare plan you have, you will either have an HSA or an FSA. HSA’s are way better tax wise, so let’s start there.

HSA’s:

• Reduce taxable income

• Can be invested and grow tax free

• Can be used tax free on future health care costs or long term care insurance premiums in the future

This is the most tax advantaged account out there. For high income earners, not using it today and letting it grow can be so impactful. But keep those receipts just in case you ever need to pull funds out pre-retirement. You can contribute up to $7,750 for a family in 2023.

If you do not have an HSA, using an FSA can be great too as it will lower your taxable income. It just cannot be invested and utilized down the line. It is typically a useit or lose-it benefit this year (with a small amount potentially being able to be rolled over).You can contribute up to $3,050 in 2023.

Another pre-tax option is a dependent care FSA. This allows you to pre-tax save money for qualified child care expenses you have. You can funnel $5,000 a year which is still impactful.

5. Donate To Charity

This is a really easy way to lower your taxable income if you have extra funds and are charitably inclined. You have donor advised funds, charitable remainder trusts, etc. that can be used to lower your taxable income. You also can donate highly appreciated securities to avoid capital gains taxes and still get a deduction. To maximize this, donate before you sell. If you don’t, you will have to pay the capital gains tax on it and just get the income deduction.

On this same note, some consider bunching charitable donations every other year to increase itemized deductions. Let’s say you make $500k and want to donate 5% a year. That is $25k. This is under $27,700 so you would take the standard deduction if you do not have a ton more. But even if you do have some more, you may barely be over the standard deduction anyway. If you do not bunch them in this example, you could you total deductions over 2 years = $55,400. Or you could bunch it all every other year.

Year 1 = Standard and get $27,700

Year 2 = Donate all $50k and get $50k deduction

Total deductions = $77,700

That is $22,300 more in deductions by doing the same thing If you are in the 37% bracket + state. That could be over $10,000 in tax savings just by being strategic around what you do and how you do it. This is what proactive tax planning looks like.

6. Invest In Real Estate

Real estate is a very tax-advantaged asset class. With bonus depreciation, cost segregation studies, 1031 exchanges, etc. you can reap a ton of rewards by utilizing this asset class.

If your spouse has Real estate professional status (REPS) or you take advantage of the short-term rental loophole, you can actually use these losses to offset other active income. Sounds great, right? Well… it is but it is not easy to pass all the tests. You definitely need to work with a tax professional if you want to consider this route.

Another good option is Qualified Opportunity Zone investing. This can make sense if you have a large capital gain from your equity comp or some other investment. If you do, you could consider putting some from the sale into an opportunity zone investment which will defer taxes till 2026 and then the growth will be tax-free if you hold for 10 years. But remember, any opportunity zone won’t work, you still need to make sure it is a good investment.

7. Roth Conversions

There are times when you will have lower income years. This could be when you move to one income, retire early, start a business, etc. This is a great time to move pre-tax to post-tax assets by doing Roth conversions and paying tax at a lower rate than you would in the future. Tax planning is all about paying tax at lower periods of time. Another good time to consider this is when the market drops and your portfolio is lower.

8. Manage Your Equity Compensation

Many high income earners get equity compensation. Whether it is RSUs, ISO’s, NSO’s, or ESPP plans, you can plan well and manage your tax liability.

Here’s a quick overview of each:

RSUs = When RSUs vest, they are taxed as ordinary income. Holding beyond that does not give you a tax benefit. But… if you are going to hold on, then you are taxed at short term capital gains rates if you hold for less than 1 year, and long term capital gains rates if greater than 1 year.

NSO’s = When you exercise, you are taxed based on the difference between exercise and market price. This will be taxed at your income rate. Then if you hold on you are taxed at either short term or long term capital gains based on the timeframe you hold for.

ISO’s = When you exercise, you have no tax unless you trigger AMT. This stands for alternative minimum tax and if triggered results in 26% or 28% added tax (most comes back as a credit in the future). Then have short term or long term capital gains based on time frame.

ESPP – With an ESPP plan, you choose to buy company shares at a discount, the best plans have a 15% discount and a look back provision. This is where it compares the fair market value of the stock at the beginning of the offering period and purchase date, then uses the lower value to calculate your purchase price. You are taxed right then around the gain you received from the look back and discount. Then, if you hold, based on the timeframe (this one is more complex and needs a post on its own) you can get either short term or long term capital gains rates.

9. Harvest Unrealized Losses on Your Investments

Under normal circumstances, you might not want to sell stock when the prices are down. However, a technique known as tax-loss harvesting can help you to “capture” those losses on paper and get a break on your income taxes.

You can take advantage of this strategy by selling investments from taxable accounts at a loss. For the 2024 tax year, the IRS will allow you to deduct up to $3,000 in losses against your regular income. You can even use this deduction to offset current and future year capital gains. You are allowed to carry losses not used in the current year forward, so if you lose more than $3,000, you can take the deduction later.

10. Non-Qualified Deferred Comp Plan

Deferred comp plans are separate from your regular income and are a way to be paid more but not actually receive it or be taxed on it until a later date.

Adding a deferred comp plan could be a great move in the right situation when you have a ton of income.

11. Utilize a 529 Plan For College Expenses

529 plans are a great way to save for college. But… Some states have a way better plan and benefits than others. In Indiana, you get a 20% tax credit up to $5,000. So if you put in $5,000, you get $1,000 back on taxes. That is a pretty great benefit. Then investments grow tax-free and they can be used tax-free on qualified college expenses.

Make sure you look into your state’s specific plan and what deductions or credits are allowed before making a decision. If you live in a state with no state income tax, they definitely have less of a benefit, but they still can be useful!

12. Do Estate Planning

Besides the basics, there are tons of estate planning strategies the wealthy can consider. You may want to utilize tools to get some money out of your estate if you will be over the estate tax exemption.

You also can gift money yearly to the family under the reporting limit, lend money at the required rates, pay for college or health care expenses, etc. to help more and not use the lifetime limit.

13. Tax Benefits from Oil & Gas Investments

Investing in oil and gas wells can provide huge tax advantages for individuals because the government wants to encourage domestic energy production. There are two main tax benefits to investing – a working interest or a mineral interest. Individuals primarily invest in the space by becoming Limited Partners, or investors, in oil & gas funds.

14. Investing in Renewable energy projects

Renewable energy is currently experiencing a surge in popularity and the Biden Administration and Congress have decided to go all in to incentivize these types of investments. As a result of that focus in Washington, buying solar energy projects has become increasingly attractive for investors — both socially and financially.

By taking advantage of solar energy project purchases, any high earner can increase their take-home income by 35% or more by reducing their taxes on capital gains and ordinary income like salary, RSUs, a bonus, business income and other sources.

If there is anything else specific you'd like to know, simply reply to this email and let us know.

1  The material in this email does not provide tax, legal, investment, or accounting advice. This is not an offer to buy or sell any security or to participate in any investment strategy. The strategies and/or investments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.