Tax Planning 101: 2023 Guide for High-Net-Worth Individuals, Part One

by | Apr 4, 2023 | News

If you are a high-net-worth individual or a high-income earner, you are probably wondering if there are any strategies that could help you lower your income tax liability. Tax experts call this tax reduction planning or tax planning.

Ratio CPA helps business owners, self-employed individuals, partners, and W-2 wage earners lower their tax burden, both on business and individual levels. We understand that navigating the world of tax planning is not easy, no matter your tax needs.

The following is a quick guide with basic information.

Tip #1: Remember that the internet contains a lot of disinformation about tax planning.

As a society, we’ve become very dependent on Google. Need to get a stain out? Google. Convert kilometers into miles? Google. Looking for a recipe? Google.

But googling tax planning solutions? That just might be a recipe for disaster.

The internet is plagued with various blogs and articles offering tax reduction advice, and though some are useful, most are either clickbait, full of errors, or an iteration of the “usual suspects” — retirement, real estate, and health savings account (HSA) strategies. While these tax strategies do help lower or defer your taxes, they won’t really put a big enough dent into the tax liability of high-income earners or high-net-worth individuals..

The authors of online content are not acquainted with your specific financial situation, have not seen your tax returns, and do not know your goals concerning cash flow or your philosophy concerning retirement savings. They also are not signing your tax returns, so their sense of liability and responsibility is minimal or nonexistent. 

At Ratio CPA, we’ve seen legitimate tax reduction strategies, backed by IRS regulations, be dragged through the mud as “abuse.” We’ve seen genuine tax deductions described as “audit triggers.” We’ve seen various misleading tips, such as the purchase of real estate by non-real estate professionals leading to tax reduction.

It’s no wonder that many high-income earners and high-net-worth individuals, whether business owners or not, are not very eager to explore tax planning. They fear tax audits, penalties, or other negative consequences.Our recommendation is to ditch Google and seek out a bona fide tax specialist, such as a CPA that specializes in tax planning — like Ratio CPA. The stakes for mistakes are simply too high!

Tip #2: Not every tax firm specializes in tax planning.

Many tax firms do not want to specialize in the field of tax reduction planning. Just as not every doctor wants to become a brain surgeon, not every CPA firm will want to put in the work, time, effort, and liability to become proficient in tax law as it relates to tax reduction.

While most accountants or CPAs will be able to offer standard advice about topics like retirement accounts, they may not have in-depth knowledge of all available retirement vehicles or recommend the simplest retirement account possible. Although a SEP IRA might be just fine for some individuals, we recently saved a client six figures by recommending a cash balance-profit sharing plan instead. The SEP IRA was a much simpler plan but not the best for the client.

Additionally, some tax planning strategies require a vast amount of due diligence and research on the part of the CPA, not only in the planning stage but also in the income tax return preparation stage. Tax strategies can make your return quite complex, and this is a part that your tax preparer must get right for you to receive the tax benefit you’ve been hoping for.

Some tax planning firms offer tax reduction plans and consultations but do not provide income tax preparation services. This might mean they are trying to limit their exposure or liability.Finally, if you work with the wrong firm or professional, you will receive a very limited range of tax strategies, or even be (incorrectly) told that nothing can be done to reduce your individual income tax liability. A misinformed CPA can cost you thousands, or even hundreds of thousands, of dollars in lost tax savings.

Tip #3: Not everyone qualifies for tax planning.

Keep in mind that our tax law is written in a way that allows only certain individuals to gain access to tax credits or tax deductions. If your tax liability is low or nonexistent, there is not much to plan for.

Your CPA’s job is to determine whether you can legitimately claim a tax strategy, without raising red flags with the IRS or finding yourself in a legal gray area.

Not everyone can claim mileage, home office, or licensing expenses—you must have a business or be self-employed and meet certain additional regulatory requirements. For example, if you do not have a designated room or section in your home that serves solely as an office, you should not be claiming a home office deduction, even if you legitimately do work from home.

There are various advanced tax reduction strategies (such as Research and Development tax credits, ERTC, 1031 exchanges, opportunity zones, and investment tax credits) that come with a long list of guidelines and requirements that must be met to claim the benefit.Additionally, some tax planning strategies come with a minimum income amount for participation – those who do not meet the income requirement cannot participate. In the case of tax reduction strategies for high income W-2 earners, an adjusted gross income exceeding $500,000 is usually preferable for tax planning to be feasible, both timewise and benefit-wise.

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Tip #4: Recognize the differences between tax preparation and tax planning.

Clients often tell us, “Our previous CPA only filed my income tax returns and did nothing to help me lower my tax liability.” But when we ask if they were paying for tax planning services, the answer is almost always, “No.”  It’s only logical that if you’re paying for income tax preparation, you should not be expecting your tax firm to provide an entirely separate service like tax planning.

What is the difference between income tax return preparation and tax planning?

When preparing an income tax return, a tax preparer looks at past documents, withholdings, estimated tax payments, investments, income, expenses, and losses to calculate whether you paid enough in taxes throughout the previous year. The tax preparer determines whether you owe the IRS money or will be receiving a refund. It is a passive and historical approach.

Tax planning looks into your future to determine what you could be doing to lower your tax liability. It is not a passive process. 

With tax planning, you may ask:

  • Could you be contributing to an IRA?
  • Are you deducting everything you are eligible for? 
  • Are there any business strategies you could be taking advantage of? 
  • Is there a better way for you to make charitable contributions? 
  • Do you qualify for any advanced tax reduction strategies, or are there any tax credits you should be claiming? 
  • Would making a change to your legal entity structure or creating a new legal entity have a positive impact on your taxes?
  • How to best structure a future purchase to optimize tax savings?
  • How to sell or buy a business for the best tax treatment?

As we mentioned above, your current tax preparer may not specialize in tax planning. Just like doctors, engineers or IT professionals have different specialties, CPAs also concentrate on different fields. Just because a tax preparer does a great job preparing your income tax return does not mean they can help you lower your tax burden.

This is why it is important to work with not just a tax preparer but with an experienced tax reduction strategist, usually a CPA, with a proven track record.

Tip #5: Keep things as simple as possible.

If you have been reading up about tax planning or have self-employment income, you might have heard about the benefits of LLCs and S Corporation (S Corp) elections. You might have spoken with a financial adviser or attorney about trusts and umbrella LLCs or holding companies.

While all these vehicles have the potential to give you amazing legal and tax reduction benefits, they all come with setup and maintenance costs and are simply not for everyone.

Tax Benefits of an S Corp

Making an S Corporation election for your LLC will usually make sense if your 1099 or business income is at a high enough level. A lot of tax savings in an S Corp come in the form of splitting your income between a W-2 (that is subject to payroll taxes) and owner distributions (that are not subject to payroll taxes, thus leading to tax savings). However, the IRS requires that you pay yourself a reasonable salary. If your S Corp income is relatively low, you may not have enough money left over in the business to pay yourself a distribution and might not benefit from the election.

Additionally, an S Corporation election will complicate your tax situation. You will need to pay a CPA to make the election with the IRS, you will now be filing an additional business return on top of your individual return (an 1120-S), you will need to have formal accounting (such as in QuickBooks Online), and you must set up payroll for yourself (such as Gusto or QuickBooks Payroll). All of this not only costs money but also requires a lot of time and effort to maintain.

Legal entity selection can be an important element of the tax planning process—but there is no need to make your financial situation more complex than it needs to be. The same can be said of trusts or holding companies.

Tip #6: Realize tax planning and investments are not the same.

Tax planning helps high-income earners, high-net-worth individuals – whether they are business owners or not – eliminate, reduce or defer their tax burden. The benefits come in the form of tax credits, tax deductions, or tax deferments. These benefits stem from tax law. Because the strategies are based on laws and regulations and not tied to performance (i.e. the stock market or the real estate market), there is a lot less risk involved than with investments.

If you purchase an investment property, flip it, and resell it, you can make a profit (and might be subject to various additional taxes, including capital gains taxes) or have a loss, in which case your losses can offset some of your tax liability. Currently, with inflation on the rise and interest rates peaking, many real estate investors are not making the money they assumed they would make. This is because investments go hand in hand with risk.

On the flip side, if you save $50,000 in taxes by making an S Corporation election for your LLC, this money is not considered income to you and will not create a taxable event. You save this money even if economic growth in the US comes to a standstill.

Investing your money and reducing your tax liability are two very different worlds. This is why high-net-worth individuals and high-income earners should take tax planning advice from tax professionals, and not financial advisers.

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Find a Trusted Tax Expert

Tax planning is a means of lowering your income tax liability and can help high-net-worth individuals and high-income earners keep more of their hard-earned money. If done right, tax savings can be very substantial.

It’s important to know that not everyone qualifies for tax planning, and not all CPAs or accountants specialize in tax reduction planning. In addition, tax planning is not the same as income tax preparation or investing.

In Part Two of this article we will talk about the various types of tax reduction strategies, including retirement strategies, business deductions, individual and business tax credits, and government incentives with a wide variety of tax benefits.

If you want to find out more about tax planning for high income earners and high net worth individuals, schedule a complimentary consultation.