5 Common (and Avoidable) Tax Planning Mistakes We See High Earners Making

As a high earner, you have a lot at stake regarding taxes. With so many deductions, credits, and strategies available, it can be overwhelming to navigate the tax code and ensure you're taking advantage of everything you're eligible for. Unfortunately, many high earners make the same mistakes regarding tax planning. Let’s discuss the most common tax planning mistakes we see high earners make and how to avoid them.

Not Taking All Allowable Deductions and Credits

One of the most common mistakes you can make as a high-earner is not taking advantage of all the deductions and credits available to you. There are many deductions and credits that can significantly lower your tax bill:

  • Electric vehicle credit

  • Solar tax credit

  • Child tax credit

  • IRA contributions deduction

  • Medical expenses deduction

  • Home office deduction

  • Mortgage interest deduction

According to the National Taxpayers Union Foundation, the top 25 percent of earners paid nearly 89 percent of all income taxes in 2020. Some of these taxes were likely avoidable. If you fall into this category, you may be able to reduce your taxes significantly. You can ask your Certified Public Accountant (CPA) or Financial Advisor to learn how to take advantage of potential deductions.

Ongoing Investments Aren't as Tax-Efficient as They Could Be

Another common mistake high earners make is not properly managing their investments for tax efficiency. For example, tax-advantaged accounts like 401(k)s and Individual Retirement Accounts (IRAs) allow you to trade, sell and buy without paying taxes. With these types of accounts, you only pay tax at withdrawal. As such, these accounts are also gaining a great deal of popularity– according to a 2022 report by the Investment Company Institute, 63% of households now have tax-advantaged retirement savings accounts.However, when you buy or sell in a standard brokerage account, the capital gains are realized immediately. To avoid paying taxes until necessary, you can also store your investments long-term and continually evaluate the tax efficiency of assets. Besides IRAs and 401(k) plans, some options for longer-term investments may include:

  • ETFs

  • Mutual Funds

  • REITs

  • Index Funds

  • Government Bonds. 

As always, ensure your portfolio is well-balanced and sufficient cash on hand if unexpected expenses arise.

Not Reporting Taxes Properly

Do you feel overwhelmed by complicated paperwork each tax season? If so, you’re not alone!High earners often use complex tax strategies to lower their tax bill, but these strategies must be appropriately reported to avoid penalties. For example, if you contribute to a Backdoor Roth IRA or a 529 plan, these must be reported on your tax return. Similarly, if you make contributions to a Health Savings Account (HSA) that were not made through payroll deductions or if you take advantage of property tax exemptions, these must also be reported correctly.Many high-earners are unaware of the property tax exemptions available to them. Based on your local rules, these exemptions may include: 

  • Homeowners exemption

  • Senior exemption (over 65)

  • Senior exemption freeze (age 65 and income less than 65k)

  • Disability exemption

Check what exemptions you qualify for in your county– it could help you to save big!

Not Leveraging Your Present and Future Tax Bracket

Taking the extra step to predict your future financial status can help you to plan in a way that maximizes tax savings.For example, if you're in a low tax bracket now but expect to be in a higher bracket in the future, it may make sense to do a backdoor Roth conversion. This means you can transfer the assets from a traditional IRA to a Roth IRA, allowing you to initially pay a lower tax rate on the money while avoiding increased income tax when it’s time to withdraw. Additionally, maxing out your 401(k) can lower your taxable income and allow your gains to grow tax-deferred. Individuals can contribute a maximum of $22,500 to their 401(k) plans in 2023 -- up from $20,500 in 2022. Some 401k plan providers even allow after-tax contributions, which opens up unique planning opportunities like mega backdoor Roth IRAs and in-plan conversions. 

Not Consciously Trying to Reduce Your Taxable Income

Finally, many high earners make the mistake of not actively reducing their taxable income. There are many ways to do this, such as contributing funds to a 401(k) or Roth IRA plan to defer tax payments or strategically giving to charity using tax-advantaged giving strategies such as a Donor Advised Fund (DAF).A DAF is a special charitable giving account that allows you to max out your charitable giving and take a deduction before actually distributing the money to charity. If you are in a time crunch, but aren’t sure what cause(s) you want to support, this could be an excellent option. If you have an exceptionally high-income year, bunching may be an option. Bunching allows you to group charitable gifts for the next two or three years into a single year, making the charitable deduction larger in the year of gifting.Additionally, if you donate cash or securities to charity, you will not have to pay taxes on capital gains, which can significantly lower your tax bill. 

Protect Your Hard-Earned Income this Tax Season

While tax planning can be complex and overwhelming, by avoiding these common mistakes, high earners can significantly lower their tax bill and keep more of their hard-earned money. It’s essential to work with your financial advisor and CPA to ensure you take advantage of all the deductions, credits, and strategies available to you and ensure that your investments and tax strategies are reported correctly. That’s why at The Dala Group, we review your previous tax returns with a fine-tooth comb to find any hidden gems, or missed savings opportunities, to help you save more on taxes in the years to come.Are you interested in learning more about the strategies we can employ to save you money this tax season? Reach out today.

This commentary reflects the personal opinions, viewpoints, and analyses of The Dala Group, LLC employees providing such comments. It should not be regarded as a description of advisory services provided by The Dala Group, LLC or performance returns of any The Dala Group, LLC client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this commentary constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. The Dala Group, LLC manages its clients’ accounts using various investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

Mike Heatwole

Mike Heatwole is a Certified Financial Planner™. He is the founder and CEO of The Dala Group. Mike graduated from the Illinois Institute of Technology with a bachelor’s degree in civil engineering and a master’s in Structural Engineering. His interest in financial planning began as a table leader for Dave Ramsey’s Financial Peace University, and shortly after, he changed careers to became a financial planner. He organically built The Dala Group, a wealth management firm, focusing on helping families achieve their lifestyle and legacy goals.

Previous
Previous

The Dala Group Celebrates Five Years

Next
Next

If the Market Goes Down, Can You Still Retire on Time?