High Income Taxpayers Have Many More Tax Provisions to Consider
As a taxpayer’s income increases, so does the complexity of their tax picture. There are numerous tax provisions that only affect high earners, and plenty of benefit phase-outs to be aware of. These provisions can interact with each other in a confusing manner, so the recommendation is always to speak with your tax expert before proceeding.
As for those tax provisions, we’ll address some of the most common here.
Capital Gains Taxes and Qualified Dividends
Capital gains refer to revenue made on the sale of an asset – an asset that may be physical or intangible. Selling a car? Capital gain. Selling stocks? Capital gain.
Capital gains are taxed on one of two schedules, depending on whether they are held short-term (less than a year) or long-term (more than a year). Short-term capital gains are taxed at the taxpayer’s highest income bracket, while long-term capital gains are taxed accordingly:
Single and married, filing single:
- $0 to $41,675 – 0 percent rate
- $41,676 to $459,750 – 15 percent rate
- $459,751 and above – 20 percent rate
Married, filing jointly:
- $0 to $83,350 – 0 percent rate
- $83,351 to $517,200 – 15 percent rate
- $517,201 and above – 20 percent rate
Head of household:
- $0 to $55,800 – 0 percent rate
- $55,801 to $488,500 – 15 percent rate
- $488,501 and above – 20 percent rate
As short-term capital gains may be taxed up to 37 percent, depending on overall income, holding onto assets for at least a year can confer major tax benefits.
In addition to capital gains, there are qualified dividends to consider. Qualified dividends are typically derived from trusts and estates, and they are taxed at lower rates than standard dividends. Those rates are:
- $0 to $2,800 – 0 percent rate
- $2,801 to $13,700 – 15 percent rate
- $13,701 and above – 20 percent rate
Itemized Deductions and Personal Exemptions
High-income taxpayers typically itemize their deductions for maximum tax benefits. For high earners, though, there are additional rules to consider when itemizing deductions. For example:
- Deductions for state and local taxes – Taxpayers may deduct a portion of their state and local taxes from their federal tax burden. However, this deduction is limited to $5,000 for single-filers, and $10,000 for joint-filers.
- Deductions for home mortgage interest – In 2017, the Tax Cuts and Jobs Act lowered the limit for the home mortgage interest deduction. Prior to 2018, homebuyers could deduct interest from home loans up to $1 million. Following the act’s passage, the limit was lowered to $750,000.
- Personal exemptions have been eliminated – The Tax Cuts and Jobs Act also eliminated the personal exemption for tax years 2018-2025. In their place, the standard deduction was increased. However, for taxpayers with older children and adult student children, losing personal exemptions means more taxable income.
Individual Retirement Arrangements (IRAs)
Many high-income earners regularly contribute funds into an employer-sponsored pension plan – including traditional and Roth IRAs. There are contribution limits to pay attention to, however. Those limits are:
- For people under 50 years old – $6,000
- For people over 50 years old – $7,000
These contributions may be deducted from taxes, but the deduction phases out within a specified modified adjusted gross income (MAGI) range. Here’s that range for 2022:
- Single-filers and head of household – phase out between $68,000 and $78,000
- Married, filing jointly – phase out between $109,000 and $129,000
- Married, filing single – phase out between $0 and $10,000
The phaseouts for Roth IRA contribution deductions look like the following for 2022:
- Single-filers and head of household – phase out between $129,000 and $144,000
- Married, filing jointly – phase out between $204,000 and $214,000
- Married, filing single – phase out between $0 and $10,000
Child and Dependent Tax Credit, and Adoption Expenses
There are also phaseouts for certain tax credits, including the Child Tax Credit. The Child Tax Credit phaseout begins at $200,000 (adjusted gross income, or AGI) for single-filers and at $400,000 for married couples filing jointly. The full tax credit is at $2,000, but for every $1,000 above the AGI threshold, the credit is reduced by $50.
Keep in mind that taxpayers can also derive a credit from non-children dependents, up to $500 per dependent who wouldn’t qualify for the Child Tax Credit.
A portion of deduction expenses can also be deducted from adjusted income. In 2022, the maximum deduction for adoption expenses is $14,890, with an AGI phaseout between $223,410 and $263,410. This deduction can be carried forward for up to five years.
Educational Tax Benefits
High-income taxpayers can take advantage of several education-focused tax benefits, but there are phaseouts here, as well. Those tax benefits and phaseouts include:
- American Opportunity Credit – The American Opportunity Credit is available for taxpayers supporting an eligible student by paying for their educational expenses. The credit’s annual limit is $2,500 for each student, and 40 percent of this credit may be refundable (it could generate a negative tax liability, in other words). The phaseout range for single filers is $80,000 to $90,000. For married couples filing jointly, the phaseout range is from $160,000 to $180,000.
- Lifetime Learning Credit – The Lifetime Learning Credit can also be used to offset the costs of certain educational expenses. This credit is non-refundable and tops out at $2,000 per tax return. The phaseout range is identical to the American Opportunity Credit phaseout.
- Coverdell Education Savings Account – A Coverdell Education Savings Account (ESA) is a special custodial account or trust that’s only used to pay for educational expenses. A named beneficiary is tied to the account, and up to a certain amount, Coverdell ESA contributions are tax-free. The maximum annual contribution is $2,000 and the phaseout range is from $95,000 to $110,000 (single filers), or $190,000 – $220,000 (married, filing jointly).
- U.S. Savings Bond Interest Exclusion – Taxpayers may exclude a portion of the interest they earn on I-bonds issued by the federal government. The exact amount is calculated on a prorated basis and depends on the amount of educational expenses and the redemption value of the bonds. For 2022, the phaseout range is $85,800 to $100,800 for single filers, and $128,650 to $158,650 for married couples, filing jointly.
- Student Loan Interest Deduction – The Student Loan Interest Deduction allows taxpayers to take a deduction on student loan interest for themselves, a spouse or a qualifying dependent. The annual limit is $2,500 and the phaseout range is from $70,000 to $85,000 (single filers) or $145,000 to $175,000 (for married couples, filing jointly).
Extra Medicare Tax
High-income earners may be responsible for an extra Medicare tax on their earned or unearned income. In both cases, the extra tax-triggering threshold is $200,000 (single-filers and head of household), $125,000 (married, filing single) or $250,000 (married, filing jointly).
Once this threshold is hit, the extra tax on any additional income is 0.9 percent. If filing a joint return, the employee’s income and their spouse’s both count toward the tax.
The extra Medicare tax on unearned income is 3.8 percent for income above the threshold. Alternatively, the taxpayer’s net investment income may be substituted for this MAGI if it is lower.
Qualified Business Income and a Couple More Exclusions
High-income taxpayers frequently have business income to add into their tax picture. For these taxpayers, the qualified business income deduction allows owners of pass-through businesses to deduct a portion of their qualified business income. This doesn’t include investment income or income from any businesses outside of the country.
For the 2022 tax year, the QBI deduction stops at certain QBI thresholds. They are:
- $170,050 for single, head of household, married filing separately and qualifying widow(er)s
- $340,100 for married couples, filing jointly.
There are a couple more exclusions for high-income taxpayers that can reduce tax burdens. They are:
- The Gift Exclusion, which is set at $16,000 for the 2022 tax year.
- The Estate Tax Exclusion, which is set at $12,060,000 for the 2022 tax year.
High-Income Taxpayers Should Work With an Experienced Tax Professional
With all of the above provisions, deductions, credits, thresholds and phaseouts, it’s extremely common for high-income taxpayers to leave some tax savings on the table.
However, an experienced tax expert can help determine these savings for their clients while providing detailed tax planning and preparation services. In this way, professional tax services can pay for themselves, especially for high-income taxpayers that have an array of provisions to consider.
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