SAMPLE: Key Tax Planning Strategies for High-Net-Worth Individuals
Are You Taking Advantage of These Four Tax Opportunities to Achieve Significant Savings?
There are many benefits that come with having a high net worth, but it also means tax planning is a bit more complex. If you don’t have a thoughtful tax strategy in place, you could miss out on key tax benefits and, when you’re paying more in taxes, that liability can have the effect of diminishing your net worth over the long term. Fortunately, the Tax Cuts and Jobs Act (TCJA), which took effect in 2018, created several opportunities for tax savings – including for earners falling into higher tax brackets.
In this article, we’ll review four of these opportunities for your consideration as you get intentional about your high-net-worth tax planning strategy.
Opportunity for Savings: Investment Tax Planning
Your investments can generate long-term wealth – yet, selling investments can also provide current income. Of course, when you sell an investment at a profit, it can trigger capital gains tax, of which there are two types.
Long-term capital gains tax rates are applied to any investments you have held for longer than a year. Short-term rates are applied to those you have held for less than a year. While short-term capital gains tax is always the same as your ordinary income tax rate, the TCJA aligned the long-term rates of 0%, 15%, and 20% with maximum taxable income levels. Before this, the 0% rate applied to the two lowest tax brackets, the 15% applied to the middle four, and the 20% was applied to investors in the highest tax bracket.
So, what does this mean if you have a high net worth? Well, if you’re in a higher tax bracket, you’ll pay more in short-term capital gains than in long-term. So, it’s critical to consider which tax rate will apply before choosing to sell off any investments in your portfolio. (You can also work toward eliminating capital gains tax altogether using a tax-loss harvesting strategy – a way to offset profits you earn by concurrently selling some of your other investments at a loss.)
Opportunity for Savings: Estate and Gift Tax Planning
Tax law changes in the TCJA affected gift and estate taxes, which can directly impact high-net-worth individuals. The new law doubled the gift, estate, and generation-skipping transfer tax (GSTT) exemptions. The tax rate for all three remains at 40%, but the exemptions for 2022 offer significant opportunities. For example, the current estate tax exemption is $12.06 million per person and the annual exclusion limit for the gift tax is $16,000 per person.
Think about this impact for a moment: Higher lifetime exemptions offer you a greater opportunity to leave behind wealth for your heirs. And, you get the benefit of minimizing taxation during your lifetime, too. If you want to fully leverage these benefits, however, you’ll need to consider whether your estate plan is structured in such a way as to take advantage of the higher estate tax limit. Additionally, you’ll want to ensure that you won’t be passing along either more or less of your wealth to your heirs than you intend to while you’re alive.
It’s also important to coordinate your federal estate tax strategy with any tax implications at the state level. Working with a tax professional you trust can ensure you don’t suffer any unintended consequences.
Opportunity for Savings: Charitable Giving Tax Planning
Many high-net-worth individuals practice philanthropy, and if you want to do good while also enjoying a tax break, charitable giving can be a savvy strategy. Since implementation of the TCJA, the IRS allows you to deduct cash contributions to eligible charitable entities, with a maximum deduction of 60% of your adjusted gross income.
If you itemize on Schedule A, these higher limits on charitable deductions can be particularly meaningful to your tax planning. For example, you might make a large, tax-free transfer of wealth by putting some assets into a charitable lead annuity trust. If you’re over age 70 ½, you can also take advantage of an additional benefit: You can avoid paying income tax on up to $100,000 annually by making charitable donations from a traditional IRA.
Opportunity for Savings: Pass-Through Entity Income Deduction
The final high-net-worth tax planning opportunity we’ll cover here relates to the 20% deduction on business income for pass-through entities. This could apply to you if you operate a business that is taxed as a pass-through, meaning you might be able to deduct 20% of your qualified business income right off the top of your earnings, although certain limitations apply. If you’re a high-income-earner and you own a business, you may find advantages in forming an LLC in order to take advantage of this significant deduction.
One thing to note is that you aren’t eligible for this pass-through entity opportunity if your business operates as a C Corporation. However, since the TCJA also reduced the corporate tax rate from 35% to 21%, there is still potential for tax savings.
Are You Practicing Strategic Tax Planning?
The U.S. tax code is complex – to say the least. It includes a number of penalties for things like underreporting income or claiming excessive tax deductions, making it smart to work with a trusted tax professional. Be sure to discuss the four high-net-worth opportunities explored above: investment tax planning, estate, and gift tax planning, charitable tax planning, and pass-through entity deduction planning. This will allow you to create the best tax planning strategy for your circumstances, while also staying on the right side of the IRS.