Beyond the Basics: Tax strategies for High Income Earners

Jenni: You see a lot of tax returns that come through. Tell me some of the common tax planning mistakes that you see made by folks. 

Gio: Yeah, that’s a great question. We see a bunch. What is great when I collaborate with you is that you tell me what happened during a clients tax year and that helps prevent a lot of mistakes. Sometimes when people are on their own, they forget to report something.  For example if you forget to complete the Roth conversion form. What happens is you went through all this legwork administratively but there’s no way to prove on your tax return from a statute of limitations standpoint, from the IRS’s point of view, that you actually have Roth balances that are generating tax free earnings. So it’s very important every year that this simple form is being reported correctly.

Another mistake is not deducting any failed startup that a founder had invested in up to a certain point. Not knowing that you can take an ordinary loss deduction, ordinary loss, meaning you can take that amount and deduct it against your W2 wages. You only have three years to fix that because of the statute of limitations on claiming a refund back from the IRS, so losing out on these these opportunities is huge.

Jenni: Do you ever see people with missed basis reporting and end up looking like it looks like they have a ton of gains? 

Gio: That’s with equity compensation when you see restricted stock units. So typically with a restricted stock unit, you would either have the basis reported by the employer or they just report nothing. Things are getting better from reporting standpoint, because employers are understanding that all their employees are overpaying an income tax because they’re not making it easy for them to prepare their own tax returns.

You’ll see a $0 basis for a lot of instances with restricted stock units that have vested and you’ll plug that into a 1099. But the next thing you know, you’re triple paying tax because your basis went from zero to being what it was which was probably no gain to even a loss because most taxpayers sell their RFCs as soon as they vest, because that’s a form of compensation and cashflow. They need that cashflow. So you sell, and in most cases, you shouldn’t even have a gain.

What Recent or Upcoming Tax Law Changes Are Relevant for High-Income Earners? (06:37)

Jenni:The tax laws always changing. Are there any things that either have changed or are being looked at that would be relevant for your high income earner?

Gio: Essentially what’s happening right now is that in 2026, a lot of the tax cuts that were implemented starting 2017 are set to expire.

So for example, let’s say you live in a state like California, New York or Massachusetts. You’re paying a ton of State income tax, and a ton in local income tax especially in the case of a New York city resident. And you’re paying a ton in property taxes in the case of a homeowner.

So with the current SALT cap (State and Local Tax) , everyone has been limited to $10,000 as far as how much you can deduct with your total aggregated state, local income tax and property tax. But that could flip and the cap may revert to $50,000 (practitioners are unsure of where it’s going to land exactly), but that could be another $40,000 in itemized deductions that may appear overnight starting in 2026 and 2027.

Jenni: That would be a big benefit for California taxpayers, for sure. Tell me about the estate tax exemption and the change that we might see with the sunset.

Gio: Great question. So for lifetime exemptions right now, Americans have also enjoyed double the lifetime exemption that Americans were historically experiencing prior to 2017. So that means that if you’re a millionaire, you have been sheltered from gift and estate tax, most likely. That is ranging between 28% and 40% as the max tax rate, and that’s taxed on your wealth.

So essentially right now if you were to die and you were married, you would have up to $28 million in assets that would be sheltered from that estate tax. But that exemption is slated to potentially be cut in half to $14 million. So $7 million, six and a half million per individual is what practitioners are thinking right now.

So if you have the ability to gift gifts and you’re planning on gifting gifts, you definitely want to do that before 2026 hits because then you increase the likelihood that they will be taxable gifts which are also subject to that same 28% to 40% percent tax that estates would be subject to.

Jenni: Most of my clients are kind of between ages of 30 to 50 and you might think, “Oh my gosh, these exemptions are huge. I’ll never get there.” But the reality is, if you’re a high income earner and you’re saving, it is definitely very possible through the power of compounding and a long life that you could end up at these higher values by the time you pass. So it’s definitely something to think about even if you’re not at those values yet.

Are there any additional deductions or credits for the normal person with W2 income that folks should be aware of? (12:20)

Gio: Another area that you can look at is short term rentals for someone that may be looking to get into real estate, has money to invest, wants to diversify and is looking for something tax efficient. We’ll talk more about real estate in a little little bit.

There are also opportunities if you own a business and let’s say you’re looking to purchase an electric vehicle. And let’s say you make above the income limit for the credit. If you’re to characterize a percentage of the this asset as a mixed use business/ personal electric vehicle, you can actually get a prorated amount of that credit, which is as much as $7,500. In addition, if you have a home office in our business and you travel often to see clients you can deduct business mileage. You’re able to take that as business miles relative to the total mileage of that particular veal vehicle and particular tax year. Let’s say the percentage of business miles is 70% m then you can take 70% of the credit effectively. So a $7,500 non refundable credit would help you a lot as far as mitigating your tax from your W2 job or your business as well.

What are some strategies for capital gains? (14:19)

Jenni: Let’s take the case of someone who is holding on to some highly appreciated assets (could be RSUs or, startup stock, real estate or some other kind of assets that appreciated. They want to diversify out, but they’re concerned about capital gains. What are some strategies for that?

Gio: So, there’s a 1031 exchange and then a 1045 exchanges exchange. A 1031 is for real estate and a 1045 is for qualified small business stock. The idea is you contribute appreciated real estate or appreciated stock into a business. And by doing that, that contribution is actually a tax free contribution. And then in exchange, you’ll receive an interest in that partnership.

And so it’s a means to help diversify your portfolio. So if you have a highly concentrated position, you can diversify into whatever that particular partnership is investing in. It could be a portfolio of stock as well. It could be a portfolio of real estate holdings, commercial, residential, anything of that nature.

By doing that, you avoid the taxable event on the front end, and then you get the diversified cash flow throughout the life of holding it.

Jenni: Yeah. And you can do something similar to this. If it’s not real estate and you’re holding stocks that are appreciated, there’s a similar idea that are called exchange funds where have stock A, you have stock B, we find a bunch of people, we pull it together. And so we’re not selling the stock, but by putting it all together and we each then get a share or a percentage ownership of that pooled fund then you can diversify without having to realize the capital gains.

What is a Charitable Remainder Trust? (15:58)

Gio: And let’s say you you have appreciated crypto or appreciated equity compensation or a rental property, and you’re not looking to do a 1031 exchange to defer and buy another. You’re done with real estate and you want to get out?

You can contribute that those assets into a charitable remainder trust. The donor of the asset is going to have the retained interest in that charitable remainder trust, and then a charity of their choosing will then be the remainder interest. At least 10 percent of what was originally contributed has to be earmarked on a present value basis for for the charity at the end.

Essentially the main benefits are you can get the asset out of your estate. It’s beneficial from that point of view, but also it’s an income tax deduction that gets reported on Schedule A.  So if you have high income, as well as this appreciated asset, you’ll be able to have a high itemized deduction as a result of this charitable deduction. And then you’re deferring the income on the appreciated asset.

So what happens eventually is that you’re going to take payouts on a fixed basis and you’ll have fixed income over a fixed period of time, depending on the terms of the trust. And at the end, the rest of the balance goes into the charity, and that kind of closes the loop on the whole process.

Jenni: I think this is a great strategy if someone is holding a large appreciated gain and who is charitably minded, right? The benefit is by putting it into this trust you get to defer the capital gains.

You put it into this trust and you still receive income from it and only when it comes out do you have to pay the tax. But what you’re benefiting from is by putting in the full appreciated value into the trust, it’s able to grow. You can still keep it invested in things and it’s able to grow and you have more from which to compound.

So it should generate more for you. In terms of lifetime income received, as well as generate this asset that you will then donate to charity. So it’s kind of a win-win in both ways. So I think this is a great strategy for folks in that situation.

What are some strategies for business owners? (22:10)

Gio: So one of the most lucrative tax planning opportunities out there for small business owners is known as Section 1202 qualified small business stock. A C corporation in which taxpayer is a founder, eventually once the business appreciates some value and the valuation grows and you’re ready to sell, you’re able to exclude the greater of $10 million in capital gains from the disposition of the C corp shares or 10 times the basis. So that’s why this is such a great and lucrative tax planning opportunity.

Jenni: I mean, this is huge, right? To get a $10 million gains exemption. So if you are a founder of startup, like this is definitely something to seriously consider even if you’re not sure what’s going to happen to your company. Then that way when you do go out and sell a portion of your stocks, you save a lot of money.

Jenni: What about if you’re a small business owner like a solo practitioner, maybe a therapist or an accountant. What should we think about?

Gio: When you’re looking service based businesses, you definitely want to look at S corporations for now. The reason for that being S corporations offer a pass through tax treatment. So there’s no double taxation like there is in the C corporation. So any income earned by the S Corp at the federal level will pass through to the individual and they would report their pay on a K1.

Right now an S corp is great because you get a qualified business income deduction, which is roughly 20% of the S corporations income depending on several factors, limitations, and the amount of income. But in addition to that you’re able to reduce the amount of self-employment tax that you pay that you would otherwise pay if you’re a sole proprietor, a single member LLC, or tax as a partnership where you’d be paying 15.3% up to $168,000 in 2024. And then anything beyond $168, 000, you’d be subject to Medicare tax and additional Medicare tax, depending on what your individual income is.

So there’s a certain level where it makes a lot of sense to become an S Corp, roughly $100,000-$120,000 in taxable business income after factoring in owner’s compensation.

How do you leave a high tax state for a lower or no tax state? (25:38)

Jenni: Switching the topic a little bit to tax residency. Again, if you’re living in a state like California, New York, you are paying a lot of taxes. So you see high income folks, especially with the ability to live remote, trying to move to lower or no tax states, or even abroad. What are the rules that decide where you are a tax resident of?

Gio: Great question. It’s important to understand the state income tax ramifications and consequences of moving from a state like California, New York, or Massachusetts to another state for not only base income but equity compensation.

So usually it’s determined on a state by state basis.  But most states are looking at 183 days as the nexus threshold. What I mean by nexus threshold is that you’re living in that state. For example, right now I’m in Utah, but I’ve only been in Utah for a couple of weeks and I don’t intend on being in Utah long term. My domicile state is New Jersey. That’s the state where my address is, where my voter’s registration is, and where  my family and friends live. So that’s my domicile state and New Jersey expects me to file a resident return with them.

If I were to be present and residing in Utah for a period of 183 days, I would be a double resident. I’d be a resident in my home state where I’m domiciled and where I’m expecting to return. Bu then I’ve been in Utah physically present and residing there for a sufficient period of time.

So usually it’s that 183 day period that you want to look at that would trigger, okay, I need to file a a resident tax return in that particular state. But going back to that example, let’s say you didn’t have a state back home, and you’re traveling, right?

Your domicile state that the state that you always intend on moving back to the state where you’re effectively connected to it’s always your resident state. Even if you’re there for a week. Even if you’re there for a day, if you intend on returning to it, you have to file a resident return in that state and you are treated as a full time resident.

So that’s, those are sort of kind of the nuances to, to that discussion.

Jenni: So if your domicile state is California (typically proved by your voter registration, your address, where your stuff is and where your family friends are), even if you left to travel around the world in an RV for a year, California would still say you’re a resident and all your income has to be taxed by California So let’s say you want to get out of California. How do you get your domicile out of a state?

Gio: For audit purposes, right? Yes, because California is going to come knocking and they’re going think that you owe 7.2% percent of your income over the past years.

So the first step is to really change all your addresses. Once you’ve effectively moved out of your residence and you move into another state, change your your addresses on your brokerage accounts, checking account, savings account, and pretty much everything.

Make sure that you have receipts for your new local gym membership. Register to vote in your new state.

You definitely want to also make sure that you’re not returning to California on a recurring basis, because that would show that you’re trying to avoid state income tax. So definitely break it up. Have a reason to come back such as coming home to see family for the holidays. Or coming home to take care of some loose ends after I moved out or something of that nature. You definitely don’t want to show have flights from Seattle to Los Angeles every weekend for two years because it would show you’re still effectively connected to that local area back in California.

Jenni: It’s a bit of a gray zone, right? It doesn’t seem like there are hard and fast rules. It is a matter of proving that your true home is in the new state. And so everything that you can do, whether it’s your gym, church, kids school, is truly in your new home state and that will help your case.

You also can’t just leave California or New York and have no other home established and just say, “I’m wandering around the world.” You must actually establish domicile somewhere else. So you’ve got to choose a place and do it. Even if you’re just nomadically traveling the world, you’ve got to choose a new domicile in order to exit an old domicile for tax residency, right?

Gio: Exactly, because then you don’t have clear and convincing evidence to the state tax authorities that you actually vacated and you’re not benefiting from the state.

Jenni: Right. Exactly. So it’s definitely a gray zone, but I think this is where it’s good to get advice. You don’t want to have a state auditor knocking at your door trying to recoup money from you.

Jenni: We have talked about a lot. Who are the types of clients that you serve? And how can people find you?

Gio: So we service many of the same types of clients. We work with folks in tech looking for income tax planning strategies and a CPA to grow with. We’re big into communication and having a strong relationship with our clients.

Jenni: I’ve really enjoyed collaborating with you on clients. You’ve been so responsive and creative in your strategy. If you’re looking for a good CPA, talk to Gojo Accountants. Thank you so much for your time.

Gio: Thank you so much, Jenni. It’s been a real pleasure being on your podcast.