The wealthy often employ strategic tax habits to minimize their liabilities. This helps enhance their financial growth by saving money and increasing profits.
These habits range from leveraging tax deductions to sophisticated investment strategies. You can also apply these habits to save considerable income and plan better finances.
Here are the 17 tax habits wealthy people use that you, too, can apply.
Claim Depreciation
Wealthy individuals often invest in real estate to generate passive income. They utilize depreciation to offset rental income, significantly reducing their taxable income. According to the IRS, you can depreciate residential properties over 27.5 years. This strategy can save thousands annually, improving cash flow from rental properties.
Deduct Business Expenses
Business owners deduct a wide range of expenses to lower their taxable income. Common deductions include office supplies, travel, and professional development costs. Small businesses often benefit from this strategy, which is essential for reducing overall tax burdens and reinvesting in the business.
Hire Your Kids
Hiring family members allows for the shifting of income to lower tax brackets. Employing children in their businesses helps in deducting their salaries as business expenses. This not only teaches financial responsibility but can also help save up to $12,000 per child. Plus, earnings paid to a child under 18 are exempt from Social Security and Medicare taxes.
Roll Forward Business Losses
The tax code permits businesses to carry forward losses, offsetting future profits. This can be a strategic advantage during lean years, preserving capital for investments. In 2023, you could carry 80% of net operating losses forward, providing tax relief. This tactic allows for the smoothing of tax liabilities across profitable years.
Earn Income From Investments
Capital gains are taxed at lower rates than ordinary income. Capital gains enjoy a maximum tax rate of 20% if a substantial portion is earned through investments. In contrast, the top rate for ordinary income can reach 37%. This disparity encourages the accumulation of assets that appreciate over time.
Sell Real Estate You Inherit
Inheriting real estate comes with the opportunity to use the step-up basis. You can recalculate the property’s value to the market value at the time of inheritance. This reset can significantly reduce the taxable amount when you sell the property. Over 50% of Americans have wealth in real estate, making this strategy valuable.
Buy Whole Life Insurance
Whole life insurance policies offer a tax-advantaged way to transfer wealth. The cash value grows tax-deferred, and benefits are out tax-free. Many wealthy individuals use life insurance as part of their estate planning. This strategy provides financial security while minimizing tax liabilities.
Buy a Yacht or Second Home
Luxury items like yachts or second homes can offer tax deductions through depreciation. You can deduct interest on loans for these properties, similar to a primary mortgage. This allows for the enjoyment of luxury assets and offers a way to reduce taxable income. The top high-net-worth individuals utilize these deductions to their advantage.
Open an HSA
Health Savings Accounts (HSAs) are triple tax-advantaged. You can benefit from tax-deductible contributions, tax-free growth, and tax-free medical withdrawals. In 2023, individuals can contribute up to $3,850, with families able to contribute $7,750. This strategy supports both health and wealth management.
Open a Solo 401(k) Plan
A Solo 401(k) offers a way to save significantly for retirement while reducing taxable income. Contributions can be up to $23,000 in 2024, with an additional $7,500 for those over 50. This allows for substantial tax-deferred growth, a key strategy for high earners. Many self-employed individuals use retirement plans to manage their taxes.
Defer Income
Deferring income to a future date can result in immediate tax savings and move you to a lower tax bracket. Techniques include delaying bonuses or using retirement accounts. This strategy hinges on the expectation of being in a lower tax bracket in the future. A lot of wealthy taxpayers defer income to manage their tax liabilities.
Harvest Tax Losses
Selling investments at a loss to offset gains is well-known as tax-loss harvesting. This can neutralize capital gains taxes and even offset up to $3,000 of ordinary income annually. More than half of affluent investors use this strategy to optimize their portfolios. It’s a proactive approach to managing investment taxes.
Move to a Lower Tax State
Relocating to states with lower income tax rates can result in significant savings. States like Florida and Texas have no state income tax, attracting affluent individuals. Over the past decade, there has been an increase in wealthy individuals moving to these states. This migration underscores the impact of state taxes on financial decisions.
Keep Good Home Records
Maintaining comprehensive records for home improvements can be crucial for tax purposes. These improvements can adjust the home’s cost basis, potentially reducing capital gains taxes. Several homeowners do not keep adequate records and miss out on tax benefits. Good documentation can save tens of thousands when it’s time to sell.
Make Charitable Donations
Charitable giving can significantly reduce taxable income through deductions. The wealthy donate to reduce their taxable income and contribute to various causes. Charitable deductions saved taxpayers millions over the years. This strategy aligns philanthropic goals with tax savings.
Make a Trust
You can use trust to manage how you distribute wealth and, in turn, tax. They offer control over assets and can help avoid probate and reduce estate taxes. Many high-net-worth families use trusts to protect and manage their assets. This estate planning tool is essential for tax-efficient wealth transfer.