As a financial planner for both high-earners and Solopreneurs, I find a common complaint from my W2 income clients that I don’t often hear from my Solopreneurs:
“It seems impossible to save on taxes.”
Yes, being a business owner is a great way to save on taxes, or as my friend Mitchell says:
“Owning a small business is the best tax deal in America.”
But this doesn’t mean there is no hope for the employed.
With great tax planning, you can reduce your taxes.
Let’s walk through the most common ways.
You can’t avoid taxes, but you can be strategic on when you pay taxes.
Retirement accounts are a great way to deploy this strategy.
In your peak earning years, you are most likely in the highest tax bracket you’ll be in.
When you contribute to a Traditional 401(k), you are avoiding income tax today and choosing to pay the taxes later when you are hopefully in a lower tax bracket.
The 2023 contribution limits are $22,500 or $30,000 if you are age 50 or older.
Don’t miss the benefits of these accounts.
If your income is too high, you aren’t able to directly contribute to a Roth IRA:
But there is a way around this.
You can make a non-deductible IRA contribution and convert it to a Roth IRA.
A thread that goes into more detail:
Now, you may be thinking I thought with a Roth IRA money goes in after tax?
Yes, in the current year you will not be receiving a tax deduction.
But a great tax strategy thinks about your lifetime tax, not just tax in the current year.
By getting money into a Roth IRA, you have an account that will now grow tax-free.
Not everyone will have access to this.
Your employer needs to offer both the option for an after-tax contribution and the ability to convert to a Roth.
If you can do this, you could potentially put an extra $43,500 into Roth accounts in one year.
That’s a LOT of money growing tax-free.
If you donate to charity, make sure you are receiving the maximum tax benefits.
The key here is donating enough that you can itemize instead of taking the standard deduction.
A great strategy to achieve this is by “bunching” donations in one year.
With a DAF, you receive a tax benefit in the year you make the contribution to the DAF.
But you are not required to send the money from the DAF to the charities that same year.
You are making an irrevocable donation to charity, but you can now take your time distributing it.
More on a DAF here:
Next to being a business owner, owning rental properties can be a great tax deal.
The key for most people is to use short-term rentals or have the non-working spouse qualify as a real estate professional.
My friend Danny has 2 great threads on this:
If you’ve been around here for any amount of time, you’ll know that I love HSAs:
The key here is you have to make sure you’re in a High Deductible HSA-Eligible Health Plan (HDHP).
And note: if you go to the doctor a lot, a HDHP may not be the best plan for you.
The key is to pay for health expenses out of pocket so you can leave your HSA alone to let it grow.
Be sure a HDHP is a good idea for you first.
Tax loss harvesting is a great strategy to use when the market is down.
It involves capturing losses in a taxable account by selling out of the fund that is at a loss and buying a similar fund.
But to avoid the “wash sale” rule (which will eliminate your loss) you have to buy a security that is not “substantially identical”.
More on TLH here:
A 529 can be a great way to save for your children’s education.
The tax deduction will depend on what your state offers.
Indiana offers a 20% tax credit up to $1,500/year.
So to maximize this benefit you’d put $7,500 into the 529.
But if your state doesn’t have income tax, this won’t benefit you.
Still, a 529 will grow tax-free and come out tax-free for qualified medical expenses.
Just be careful not to overfund the account.
More on 529s here:
Not every strategy here will work for you.
You have to analyze your cash flow, tax rate, estimated future tax, desired lifestyle, and be sure it's all filed correctly (surprisingly this is a big mistake I see).
Be sure to work with someone who helps clients similar to you.
Having a team where the financial planner and CPA are on the same page can be invaluable.
Remember to think about “lifetime” tax here and not just tax savings in the current year.
And ALWAYS consult with a CPA and financial professional first.