As unfair as it may be, the richest Americans pay the lowest tax rates. A recent study by the National Bureau of Economic Research found that the top 0.0002% of Americans paid an average tax rate of 24% from 2018 to 2020, compared to 30% for the full population and 45% for top labor income earners.
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These high-income professionals — the “middle rich” — earn too much for W-2 simplicity and too little for offshore trusts, so they’re often stuck with a high tax bill. However, there are legal and ethical ways to lower your tax bill if you fall into this category.
Here’s how the “middle rich” can score major tax savings.
Start Early To Maximize Tax Savings
One way to save big on your taxes is to start preparing way ahead of Tax Day.
“The biggest savings come from planning in August, not April,” said Melanie Chesir, CPA, senior tax manager at Gelt. “Choose a tax pro early on so that they are with you before tax season, specifically before the year ends, to help with year-end projections and optimizing estimated taxes.”
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Avoid IRS Penalties With Accurate Estimates
Incorrectly estimating your taxes and paying less than you owe can cost you big in terms of penalties.
“The IRS estimated tax penalties are effectively an interest rate of 8%,” Chesir said. “You want to be on top of tracking estimated taxes to ensure you pay sufficiently. Have a tax pro who can guide you accordingly.”
Time Your Tax Moves Strategically
When you have a more complex tax situation, it can be hard to know the best time to make moves that will optimize your tax strategy. Chesir recommended working with a professional to ensure you get the timing right.
“Reach out to your tax pro before you make the move to ensure you are doing it properly — for example, filing 83b elections when relevant, or checking whether it makes sense to exercise their options this year or wait,” she said. “The taxpayers who ask their accountants the questions before they take the actions are the ones who ultimately save more on their tax bill.”
Choose the Right Business Structure
When you have your own business, it’s important to understand the pros and cons of the various business structures you can choose, such as LLCs or S Corps.
“The wrong business structure could mean paying double in self-employment taxes,” Chesir said. “This is something that needs to be dealt with long before tax season, as there is a lot that needs to be done in advance to make the proper structure effective when you want it to be.”
Maximize Deductions
Business owners qualify for special deductions that W-2 employees do not.
“If you have a business, ensure you are capturing all deductions available to you,” Chesir said. “If you have certain expenses that are mixed between business and personal, you need to track those closely to ensure you don’t miss any deductions.”
Integrate All Income Types Into Your Strategy
High earners with mixed income — W-2, 1099 and/or investments — lose out on tax savings when they plan for each type of income in silos, Chesir said.
“You need to properly time investment losses to coincide with high income years, donate appreciated stock in high income years, and recognize stock gains or do Roth conversions in low income years — i.e., when in between jobs,” she said.
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This article originally appeared on GOBankingRates.com: 6 Ways the ‘Middle Rich’ Can Slash Their Tax Bills, According to an Accountant
