Tax Deductions for High Income Families/ Earners (Tax Series Part 3)

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Let’s pick up where we left off with more tax deductions for high income families.

You can see the first part of the series, Tax Credits for High Income Families/Earners here

The first part of Tax Deductions for High Income Families/Earners is here.

 

Tax Deductions For High Income Families

 

Medical and Dental Expenses

Qualified medical expenses are deductible as long as the amount exceeds 10% of your adjusted gross income (AGI). If you are over 65, the limit is 7.5%. Even if you have a high deductible plan, it is unlikely that your deductible will be over 10% of your AGI.  

For example, if you meet your $10,000 deductible, but your AGI is $200,000, you still have another $10,000 in medical expenses before you can deduct the medical costs.

Most anything required from a doctor is deductible. This includes prescriptions, radiological testing, doctor’s office appointments and hospital visits.

Nicotine gum bought over the counter (without a prescription), most cosmetic surgery, toiletries, funeral expenses and health share organization contributions are not deductible.

 

Health Savings Accounts (HSA)

Now, this is a gold mine for high income earners. If you have an HSA qualified high deductible health plan (QHDHP), you can contribute $3,400 for an individual or $6,750 for a family. The contribution is tax deductible and all the gains from investment are tax-free as long as you spend the money on qualified medical costs.

My plan for our HSA is to not touch it until we are in our 60’s. I want that money to grow tax-free and save receipts from our medical bills along the way.  We can withdraw the money from an HSA at any time. It doesn’t have to be in the year the medical expense occurred.

The average American spends most of their medical funds once they are over 65 and over five times the average in the last year of life. This money will be better spent in the future and we can allow the magic of compound interest to build up our medical funds for our golden years.

 

Deductible Taxes

Thankfully there are some taxes that are deductible by the federal government so we are not double taxed. These include,

  • state local and foreign income tax
  • local and state sales tax
  • state, local and foreign property tax
  • state and local personal property tax

Payments (or taxes) into social security are not deductible.

Local entities collect personal property tax based on the value of something you own. It could be a boat, RV, or car. This depends on where you live and what the tax rate is there.

Real estate taxes (or sometimes called property taxes) are paid to a local municipality. These are usually charged yearly. They are charged to cover local city government, schools, roads and other local projects.

Sales tax is the amount of tax you are charged when you buy something in a local store. This is becoming more and more interesting as e-commerce laws start to pop up. You used to be able to buy something from Amazon or another web based store without paying sales tax but if that website has a presence in your state, they are starting to collect local sales taxes.  

You could keep track of all the sales tax you pay during the year and add it all up (glutton for punishment) or just use the convenient calculator the IRS has set up for us based on location and income. This is the link –> IRS Sales Tax Calculator

The more of a minimalist you are, the more likely the calculator will be in your best interest. If you spend every last dime on local consumables, keeping all your receipts could come out ahead. It would be an interesting experiment.

Charitable Contributions

You would think this one would be easy. You don’t have to pay taxes on any funds given to a qualified charity. The IRS exemption select tool will allow you to see if your charitable organization qualifies.

We can thank representative Don Pease (D-OH) for complicating the issue. If your AGI is over the limits in this table:
tax deductions for high income families

your itemized deductions are limited by either:

  • 3% of your AGI over the income limits above or
  • 80% of your total itemized deductions allowed.

It gets further complicated in that some itemized deductions apply to the Pease limitations and others do not.

The deductions that are NOT subject to the Pease limitations are:

  1.  medical expenses
  2. investment expenses
  3. gambling losses, and
  4. certain theft and casualty losses

The deductions that are subject to the Pease limitations are:

  1. charitable donations,
  2. the home mortgage interest deduction
  3. state and local tax deductions
  4. other  miscellaneous itemized deductions

 

Exciting Examples (eyes glaze over)

For example, we have a married couple making $450,000 a year.  They have itemized deductions of $150,000. The charitable contribution portion of that is $45,000. The allowable itemized deductions would be $450,000-313,800 = $136,200 X 3% = $4,086.

This means their allowable itemized deductions are $150,000-$4,086 = $145,914.

Another Example

The 80% rule comes into play when you have a high income and few itemized deductions.  Say you make $750,000 as a married couple and your itemized deductions are $4,000.  You’re over the $313,800 limit by $436,200.

3% of $436,200 is $13,086.

80% of total deduction is $3,200.

Therefore, the allowable deductions would be $4,000-$3,200 = $800 (WooHoo!) since $3,200 is less than $13,086. 

 

Gambling Losses

You can deduct your gambling losses up to the amount you won.  Since we are investors and not gamblers, this shouldn’t be a big part of your deductions. 

 

Miscellaneous and the 2% Rule

If the deduction falls in the category of miscellaneous deduction, then you can’t claim these until they are over 2% of your AGI. In other words, if you make $200,000 AGI, you can claim these deductions over $4,000. 

The list of miscellaneous deduction is way too long to type out but you can find the entire list at IRS Publication 529.  

This was interesting. If you have invested in an IRA, taken all the distributions from that IRA, and still lost money, you can deduct the loss over 2% of your AGI. Hopefully, this never comes into play for you.

 

Interest Deductions

You can deduct interest paid on student loans (if you qualify) and on mortgages. These are the only nonbusiness expense interest deductions allowed. Mortgage-related points paid and mortgage insurance payments may also be deducted. 

 

Union Dues, Professional Society and Chamber of Commerce Memberships Expenses

You can deduct the dues paid for these groups if being a member is helpful to your profession. You may have to prove this if audited.  

 

Moving Expenses

Moving Expenses are deductible if you meet the distance and the time test. 

  • Distance test – Your new job must be 50 miles farther away from your home than your old job was. 
  • Time Test
    • If you are an employee, you must work at least 39 weeks in the following year of your arrival at the new job location to qualify.
    • For self-employed, you have to work 39 weeks in the first year and 78 weeks in the first 24 months following arrival. 

 

Alimony Payment

You can deduct alimony payment, even if you don’t itemize your deductions. You probably will need your ex/spouse’s social security number to be eligible.

 

Casualty, Disaster and Theft Loss

Hopefully, you never experience any of these, but if you have further losses after you have salvaged and collected insurance claims for any loss due to theft or natural disaster, these losses are deductible. Of course, they don’t make this easy for high income earners either. 

After you have subtracted salvage and insurance claims, you subtract another $100 for each loss event. Then you subtract 10% of your income. If your AGI is $400,000, you have to lose more than $40,000 before you can claim a deduction.

I guess that is why we have insurance. Getting someone to steal your stuff isn’t an effective tax avoidance strategy. 

 

Standard Deduction

Every taxpayer is entitled to the standard deduction.  This table shows the standard deduction for each situation:

tax deductions for high income families

 

You can only claim the standard deduction if you are not itemizing your deductions. 

 

Additional Standard Deduction

If you are age 65 or older by the end of the tax filing year or you ar legally blind, you can claim additional standard deductions. 

Single or Head of Household – $1550

Married Filing Jointly – $1250 for each individual that meets the criteria.

 

Personal Exemption

The personal exemption amount for 2017 is $4,050. However, the exemption is subject to a phase-out that begins with adjusted gross incomes in the table below:

tax deductions for high income families

 

If your AGI is above the upper limit, you won’t get to take any of the personal exemption.  For every $2500 over the lower limit, there is a 2% personal exemption reduction. 

 

Make Those Deductions Count

Higher earners have the opportunity for higher deductions. As you invest in real estate, there are several opportunities for deductions there.  Income phaseouts seem to be a popular way for taxes to be “hidden” by those that make the tax laws. It just goes to show you that finding ways to reduce your AGI through tax deferment (401k, etc) and investing in a business and real estate can drop your overall tax burden.

Just remember that paying for a deduction is a losing proposition.  Even if you are in the 39.6% tax bracket, it doesn’t make sense to lose $1.00 to save 40 cents.

If you have any questions or need clarification, leave a comment below. Thanks for reading and commenting. 

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Tom
Tom is a doctor, husband and father of five with a passion for parenting and finance. When he isn't skateboarding, riding BMX, or jumping on the trampoline with his kids, he is reading and writing about personal finance. He helps high income parents educate and mentor their kids to become financially, emotionally, and intellectually self sufficient.

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