Tax Planning Strategies for High Net-Worth Individuals

Eric M. Solve, CFP®, EA
Eric M. Solve, CFP®, EA
high-net-worth individuals

Having a higher net worth affords you many benefits, but it also means tax planning is a bit more of a chore. Without a thoughtful tax strategy, you run the risk of missing out on key tax benefits and, when you’re paying more in taxes, that liability can begin to diminish your net worth over time. Fortunately, there are several opportunities for tax savings, including for earners in higher tax brackets. Below, we’ll review four of these opportunities for your consideration as part of your high-net-worth tax planning strategy.

Investment Tax Planning Opportunities

Your investments can generate long-term wealth; however, selling investments can generate capital gains tax.

There are two types of capital gains tax, short term, and long term. Short-term capital gains tax rates are applied to investments held for less than one year, while long-term rates are applied to investments held for more than a year. Short-term capital gains tax is always the same as your ordinary income tax rate, while long-term rates are taxed at either 0%, 15%, or 20%, based on your taxable income level.

What does it all mean? Well, if you’re in a higher tax bracket, you’ll pay more in short-term capital gains than in long-term capital gains. So, it serves you to consider your holding period and which tax rate will apply before selling off any investments in your portfolio. And, if you’d like to work toward eliminating a capital gains tax bite altogether, you may consider using a tax-loss harvesting strategy. Ostensibly, it’s a way to offset profits you earn by also selling some of your investments at a loss.


SEE ALSO: Health Savings Accounts Provide a Simple Tax Break for High-Income Earners


Estate and Gift Tax Planning

After the Tax Cuts and Jobs Act (TCJA), the gift, estate, and generation-skipping transfer tax (GSTT) exemptions doubled. The tax rate for all three remains at 40%, but the increased exemptions for 2021 offer significant opportunities. For example, the current estate tax exemption is $11.7 million per person and the annual exclusion limit for the gift tax is $15,000 per person.

Higher lifetime exemptions offer you a greater opportunity to leave behind wealth for your children and grandchildren and minimize taxation during your lifetime. In order to fully leverage these benefits, 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. You’ll also want to ensure you won’t be passing on more or less of your wealth to your heirs than you intend to while you’re alive.

The increase in the estate tax exemption is currently set to expire (sunset) at the end of 2025.  If there are no changes to the existing law between now and 2025, the exemption will drop back to what it was prior to the TCJA; which was $5.0 million.  When adjusted for inflation, the exemption will be somewhere between $5.40 and $6.0 million.

Note: Don’t forget to coordinate your federal estate tax strategy with any tax implications that may be triggered at the state level. Working with a tax professional can ensure you don’t suffer any unintended consequences.

Opportunities Charitable Giving Tax Planning Opportunities

If you want to do good while also enjoying a tax break, charitable giving can be an attractive strategy for high-net-worth individuals. The IRS allows you to deduct cash contributions to eligible charitable entities, with a maximum deduction of 60% of your adjusted gross income (AGI).  With the passage of the Consolidated Appropriations Act (CAA), for 2021, the maximum deduction for qualifying cash contributions is up to 100% of AGI.

If you are high-net-worth and you itemize your deductions, these higher limits on charitable deductions can be quite meaningful to your tax planning. Consider, for example, that you could make a large, tax-free transfer of wealth by putting some assets into a charitable lead annuity trust.

If you’re over age 70 1/2 you can also take advantage of an additional benefit. You can avoid paying income tax on up to $100,000 annually by making qualified charitable contributions (QCD) from a traditional IRA.  For individuals that are already taking required minimum distributions (RMD’s) from their traditional IRAs, amounts distributed as a QCD will be counted towards satisfying your RMD for the year, up to the $100,000 maximum.

For Individuals with highly appreciated stocks, you may want to consider opening a donor-advised fund (DAF).  If you are eligible to claim itemized deductions for federal and/or state income purposes, contributions to the DAF are considered tax-deductible charitable contributions.  Transferring shares to a DAF allows you to receive a tax deduction in the year you transfer the stock, but you can make grants to your preferred charitable organizations at any point in the future.


SEE ALSO: Planned Giving Goes Further


Pass-Through Entity Income Deduction Opportunities

The final tax opportunity we encourage high-net-worth individuals to consider relates to the 20% deduction on business income for pass-through entities. This may apply to you if you operate a business that is taxed as a pass-through. Specifically, it means that you may be able to deduct 20% of your qualified business income off the top of your earnings (with certain limitations). 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.

Note that you cannot take advantage of the pass-through entity opportunity if your business operates as a C Corporation. However, the TCJA reduced the corporate tax rate from 35% to 21%, providing another area for potential tax savings impact.

Further Guidance for High-Net-Worth Individuals

With all the intricacies involved in the U.S. tax code and penalties for underreporting income or claiming excessive tax deductions, it is important to work with a trusted tax professional. As you do, be sure to discuss the four topics explored in this article: investment tax planning, estate, and gift tax planning, charitable tax planning, and pass-through entity deduction planning. Doing so will ensure you can create the best tax planning strategy for your circumstances, while also ensuring you remain on the right side of the IRS.

With a carefully developed strategy that addresses the above factors, you can enjoy optimally minimized tax liability and ensure that you can retain more of your money.

This communication contains the opinions of Wade Financial Advisory, Inc. about the securities, investments and/or economic subjects discussed as of the date set forth herein. This communication is intended for information purposes only and does not recommend or solicit the purchase or sale of specific securities or investment services. Readers should not infer or assume that any securities, sectors or markets described were or will be profitable or are appropriate to meet the objectives, situation or needs of a particular individual or family, as the implementation of any financial strategy should only be made after consultation with your attorney, tax advisor and investment advisor. All material presented is compiled from sources believed to be reliable, but accuracy or completeness cannot be guaranteed. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. INVESTMENTS BEAR RISK INCLUDING THE POSSIBLE LOSS OF INVESTED PRINCIPAL.

Wade Financial Advisory, Inc. is an investment adviser registered with the Securities and Exchange Commission. Registration of an Investment Advisor does not imply any level of skill or training. A copy of current Form ADV Part 2A is available upon request or at www.advisorinfo.sec.gov. Please contact Wade Financial Advisory, Inc. at (408) 369-7399 with any questions.

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