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5 Tax Deductions for High Earners (plus a Tax Hack)

By Jimmy Turner, MD
The Physician Philosopher

2020 was the first year I used a CPA to file my taxes after having to explain to a well-known online tax software how to fill out my Form 8606 for my Backdoor Roth IRA and receiving a tax bill of more than $10,000. Why did this happen?  Well, because I previously failed to understand the tax deductions that exist for high earners.

I don’t want that to happen to you, though.  Let’s dive into 5 tax deductions for high earners and a tax hack that many high-income earners don’t consider.

Marginal versus Effective Tax Rate

Before we talk tax deductions, let’s make sure we are on the same page in terms of tax definitions.  Your effective tax rate is your “average” tax rate (Total Tax Paid / Taxable Income). Your marginal tax rate is how much the last dollar you made gets taxed. 

To determine your marginal tax rate you can use tax software, or simply ask your accountant to increase your income by $100 and see how much more tax you would have paid.  If they say $30 – then your marginal tax rate is 30%.

Once you know this number, any charitable giving you provide will save you that percentage on your taxes. So, if you give $10,000 in our hypothetical example, you would save $3,000 in taxes.  

For example, my family’s marginal tax rate for 2019 was 35% just from the federal side. If we add in the NC state tax (5.25%) and some self-employment taxes, our marginal rate rises over 40%.  So, for every dollar that we place into the tax-advantaged space, we saved 40 cents on the dollar. 

In other words, for every $10,000 tax deduction we can find, that will save us $4,000 in taxes paid.   Which is great because it aligns with our value system in addition to saving some money on taxes.

Alright, now that you’ve got the basics.  Here are 5 tax deductions for high earners plus a 6th tax hack at the end of the post.

1. Retirement Contributions

One of the best ways that you can lower your taxable income is through pre-tax retirement contributions.  For example, in 2023, we plan to deduct all of the following from our taxable income:

In total this is going to decrease $52,600 from our taxable income.  

Note: If you are in an Income-Driven Repayment program for your student loans, the contributions above will decrease your monthly payment as well, which is dependent on your Adjusted Gross Income.

2. Charitable Giving

Of all the itemized tax deductions for high earners, charitable giving is the one you have the most control over.  It’s not like the pre-determined interest rate on your home or the capped SALT deductions mentioned below. You can determine for yourself how much you plan to give.

Many people aim to give 10% of their taxable income each year to charity.  How much you should give is a highly personal question, but I suggest you set a goal each year and then try to achieve it.

With each dollar that you put towards charity, you will shave money that gets taxed on the back-end.  For many high-income earners, this ends up being substantial given the progress tax-bracket system we have in place.

3. Mortgage Interest

Your mortgage interest is also deductible up to $1,000,000 if married filing jointly ($500,000 if married filing separately).  Given the high-interest rate environment of 2023, this is a big tax saving for many people.

On a $600,000 at 7% interest, that is a tax savings of $42,000.  Not too shabby considering that the standard deduction for married couples filing jointly is $27,700 ($13,850 if single). 

4. SALT Deduction

This one is essentially automatic for any physician.  The State and Local Tax (SALT) deduction caps at $10,000.  Given that the state tax rate where we live in North Carolina is 5.25%, we hit this number pretty easily.

However, it is one more deduction that still encourages my family to itemize instead of taking the standard deduction.  With our mortgage interest and SALT deduction we are well above the standard $24,000 deduction.

5. Child Tax Credit

If you earn less than $400,000 you get a child tax credit (i.e. dollar for dollar deduction on your taxes) for each child you have.  The number is $2,000 per kid.  For a family with 3 children, that is a potential $6,000 in direct tax savings for each child if we can get our taxable income below $400,000.

In some ways, this becomes a bit of a game as our taxable income is usually right around that number. If your income is close to threshold, figuring out how to get it below $400,000 becomes the goal.  

6. Alternating Years

The last tax trick you might consider applying as a high-income earner is alternating the years in which you take the standard deduction and the years in which you itemize.

For example, let’s say that you have paid off your mortgage.  You give $25,000 to charity annually and have $10,000 in SALT deductions.  Instead of deducting $35,000 itemized each year, you could double up on your charitable giving every other year.

Doing this, you would give zero dollars to charity in one year, and then give double ($50,000) in the other years.

Alternating Standard and Itemized Deductions Case Study

If you were to itemize each year using the $10,000 SALT and $25,000 charitable giving, it would look like the following:

  • First Year: Itemized Deduction of $35,000
  • Second Year: Itemized Deduction of $35,000
  • Third Year: Itemized Deduction of $35,000
  • Fourth Year: Itemized Deduction of $35,000

Your total deduction over this time period would be $140,000.

What would it look like if we alternated each year instead by doubling up on charitble giving every other year and taking the standard deduction in the others?

It would look like the following:

  • First Year: Standard deduction of $27,700
  • Second Year: Itemized deduction of $60,000 ($50,000 charitable giving + $10,000 SALT)
  • Third Year: Standard deduction of $27,700
  • Fourth Year: Itemized Deduction of $60,000

Total tax deductions: $175,400 

Using this technique, you would give the same amount to charitble causes ($25,000 per year on average).  Despite the same charitable giving effort, you would save an additional $35,400 in taxable income over the same time period, becuase you are maximizing the deduction provided by the government in years 1 and 3.

If you have a 40% marginal tax rate, that would be $11,200 back in your pocket over those 4 years.  That’s $2,800 per year.  Not too bad.  

Note: This particular strategy works well when the interest from any mortgage you have does not “bump” you over the standard deduction.

Take Home

While there are other wasys to reduce your tax burden, including real estate investments, this article highlighted six of the more common ways you can lower your overall tax burden as a high-income earner.

You don’t have to understand everything about taxes, but you do have to understand enough to make smart personal finance decisions.   

4 Comments

  1. Crystal

    Congrats if you are each getting away with deferring both your 457, your 403b, AND your 401ks cumulatively. In reality (legally), you are only allowed to deduct a *TOTAL* of $19,500 of pre-tax dollars each, across all of those accounts. The total retirement contributions (pre/post/company match) across all retirement accounts in 2020 is $57,000 per individual. Only $19,500 of that can be Tax Deferred.

    Reply
  2. Jason

    If your county bumpkin accountant let you each defer more than 19,500 (total) in retirement contributions, you should look for another accountant. If you’ve been doing this for several years, as a result for preparing your own taxes, you should rectify the errors, and file adjustments for each year, as this can set you up for a MAJOR MAJOR headache (with penalties) when you are in your 60s.

    Reply

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