Tax Basics High Income Earners Should Know

5 Essential Tax Basics for High-Income Earners

In this episode of the Retire Early Retire Now Podcast, host Hunter Kelly, owner of Palm Valley Wealth Management, discusses five key tax concepts every high-income earner should understand. Hunter emphasizes the importance of knowing about marginal and progressive tax rates, capital gains taxation based on holding periods, the difference between deductions and credits, and the taxation of bonuses. The episode aims to help listeners reduce their tax liabilities and better manage their finances as they approach tax season.

00:00 Introduction to the Podcast

00:27 Sharing and Reviewing the Podcast

01:14 Understanding Marginal Taxes

06:23 Progressive Tax System Explained

07:46 Capital Gains and Tax Timing

10:22 Deductions vs. Credits

14:04 Taxation of Bonuses

15:56 Summary and Conclusion

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Transcript

0:00

And welcome to the retire early retire now podcast. I'm your host hunter Kelly owner, Palm valley wealth management. And today we're going to talk about five tax basics that every high income earner should know. Uh, this will help you get a better understanding of where your tax dollars are going, but also help you minimize that tax bill moving forward. Once you understand these basics, then you can start looking for. Opportunities to help you save on taxes. But before we jump in. Go ahead and share this podcast with your friends tax season is upon us January. Be here before we know it. You'll be receiving W2's working on your profit losses. If you own a business. Uh, things of that nature. So, uh, would love to, to spread this great information about these tax basics to help you. Uh, move forward in your financial journey. Uh, and help you keep more dollars in your pocket. So, I'll go ahead and share that and leave a five star review on your favorite podcasting app. You can also find this, uh, as a video on YouTube, just look up hunter, Kelly, CFP, uh, and then you'll see that as a YouTube video as well. But let's jump right into it. So. Again, like I said, we're going to talk about five key concepts that I think. Every high-income earner should know. Uh, In regarding to, uh, taxes. So the first thing, a lot of these are just misconceptions. So when I meet with clients, Uh, meet with prospective clients and we start talking about taxes. A lot of times these concepts are. Um, not understood. So, uh, one is want to go over these, but two, you need a good understanding of these so that you can understand your tax situation a bit better. So the first one would be, uh, taxes are marginal. So what does this mean? So. Taxes being marginal means as you earn more income. You will be taxed at a higher rate on those new dollars coming in. So as it stands now, if a tax, uh, earner is making. Uh, tax pain. If an individual is making more than, let's say$200,000. This means that the top dollar, so the$201,000, uh, that, that last dollar will be taxed at a different rate than that first dollar that came in. Right. So. Our tax, uh, again, our taxes are marginal, so those last dollars will maybe tax at a 24% rate depending on their filing jointly or as a single person. Um, but that first. A couple of months technically would be taxed at like a 10 or 12% tax rate. Right. So forget about deductions and things of that nature right now. But, um, so as you earn more money, that tax rate on those new, higher dollars coming in will be taxed at a larger percentage. And so, um, this can be a good, in a sense that a couple of things, one. Uh, if you look at it from like a, uh, economy standpoint, if you're making more money than quote unquote you're, you're paying more of your share toward the federal government and those taxes towards social security, Medicare, things of that nature. Versus someone that is lower income. Um, having to spend, uh, 30, uh, To 35% of their income. Uh, toward taxes, obviously someone making$50,000 paying 30% versus someone making$500,000 making 30%. Um, is a bit different. Yes. The person making$500,000 is going to is going to pay a more of a dollar amount, but they would also have quite a bit leftover as well. So, um, It's a good thing for our lower income earners, uh, that they don't have to pay is such a high rate. Uh, as our higher income earners, um, but also it gives you opportunities, uh, to plan for your taxes, uh, would, would such timing strategies, right? So. Uh, for example, if you have a year where maybe you, you have a lower income year, this could be a good time to do either Roth contributions, maybe because you've been making too much. You haven't had the ability to, to just do a normal contributions or you could do conversions, right? So if you have large amount in pre-tax dollars and you take a year off or you have some sort of lower income year for whatever number of reasons you can convert. Um, at maybe a lower tax rate. So let's say that your, your marginal tax rate was, uh, uh, 37 and a half percent. And for whatever reason you take a couple of years off and now you have essentially no income. Well, now you can start to convert some of that pretax money. Uh, that you would have had. That you would have differed at maybe a 37 and a half percent and you convert and pay. Let's say a 10, 12, 20, even 20%. Uh, there's a big difference there. And so you'll make up that Delta. The other thing that you could consider as well, um, would be potentially selling appreciated stock, right? So. Um, if you, uh, just like, uh, income taxes, your. Capital gains rates are based off your income as well. So maybe your, your income is low enough that maybe you wouldn't even owe capital gains rates. Or a capital gain taxes. On the particular stock. Right? So if your income is low enough, I think for someone filing jointly it's around$90,000. Uh, if you were to sell. Uh, those stocks and your income was well under that$90,000. Well, then now I can potentially have these gains at a 0% tax rate, or maybe your income was such that your capital gains rate was at 20% and now, um, because your income has lowered, you can get it at a 15% rate. So again, Uh, these are some timing, operative tax planning opportunities that you could potentially take advantage of, uh, in a situation where you have some fluctuating income. And so that is marginal tax rate. The more you make the higher, that, that bracket is going to be that percentage on those next dollars. And so to kind of add onto that from number two, Taxes are progressive. So, um, again, as you make more income, your tax rate is going to be higher and higher, right? So, um, so again, if you're making$50,000 versus making$500,000, uh, your tax liability is going to grow incrementally. So again, As our tax code stands now. It starts at, uh, 10% works its way up to 12%, 22%, 24%, all the way up to 37 and a half percent, uh, based off your income brackets. And, uh, it changes a bit if you're single versus married, things of that nature. Right. So. It was a progressive system. Um, that ensures fairness, right? Um, or at least that's the intent. Is to, uh, show fairness to create opportunities and taxes. Uh, strategies like deductions and referrals and things of that nature. Um, but as those, uh, more high income earners. Uh, earn their income. There'll be taxed a little bit more. And so it allows for those lower income earners to. Um, keep more of their money to hopefully potentially save, invest, or create more opportunities to create more income and wealth for themselves. Right. Um, the third thing, capital gains. Uh, and we kind of mentioned this just a second. Go. Uh, capital gains are based off time on how they're taxed. Uh, and so a lot of people don't understand this. So you buy a stockless you buy Google. Uh, today, right? December 3rd, 2024. You buy Google and you sell Google. Uh, let's say February 5th, 2025. You're going to be taxed differently. Then, if you sold Google on December 4th, 2025. And so. Depending on how long you hold that stock. Depends on how you're going to be taxed. They're both considered capital gains. Assuming you have a gain in Google. Um, but, uh, the w the bracket or the amount of tax that you will pay will be, uh, potentially significant, um, depending on how long you hold it. So if you held Google less than one year, it will be taxed as ordinary income. So if you're a tax bracket, um, for your income, Is 37 and a half percent. Those new gains will be taxed at that 37 and a half percent. But if you held Google until December 4th of next year, you would be taxed. Um, at a lower rate, either depending on your income at a 20% rate or at a. Uh, 15% rates. So, uh, that is one thing that you want to consider. How long do I want to hold the stock? Um, Uh, doesn't make more sense for me to hold it. Long-term meaning more than a year. Or, uh, is my tax situation or the gain at such where. Um, it's okay for me to sell. Um, within less than a year. Because I've got enough gain out of it. And I don't want to necessarily risk losing some of that gain, whatever that case may be. Um, obviously some things that you have to consider there, but. But this is why investing can be very advantageous even outside of retirement accounts. Because if you're holding, um, longer than a year, which is what the IRS has kind of incentivizing here. If you're holding those stocks for longer than a year, you're going to get a more advantageous or more favorable tax rate. Uh, then if you bought and sold within less than a year, Okay. Um, And so the next thing, right? Uh, number four, another. Um, Another kind of misconception. Uh, deductions versus credit. So deductions are, um, something that lower your tax liability, but not dollar for dollar. Right? So, um, the common thing is if you are a business owner, right, uh, You get some extra added expenses and deductions and things of that nature. If you're purchasing those things because of the business. Well, if you go out and you buy a$10,000 widget machine piece of equipment, whatever you need for your business. You're not getting a$10,000 tax. Reduction. Um, And your payment or that you, your liability that you're going to owe in that year. Right? You're maybe getting a$2,400 reduction or what have you. So, um, it would almost be like going out and buying. Uh, or. Putting$10,000 worth of, uh, Shopping spree on your credit card. Um, knowing that you're going to get a 2% reward, right. So it doesn't make sense to spend$10,000. To get a$2,000 back, right. Or$200 back. So, uh, you really have to think about this, right? And understand the difference on, um, what a, uh, deduction is and what it isn't. Obviously, if it's a piece of machine or technology, whatever you're spending that money on for the business. Um, or something in your personal tax return that you definitely need. Then obviously purchasing that will reduce your tax liability and it will be a good thing, right? Um, And so the, the other thing I do want to mention here, um, is itemizing versus the standard deduction. Uh, when Trump came in in 2016 and then implemented his tax new tax bill. Uh, much everybody at this point uses the standard deduction and. All that means is that the IRS is giving you. Giving you a deduction off the top. Um, From your income. So if you make a hundred thousand dollars a year and you take that standard deduction, Um, Now let's say you're married, filing jointly. Your joint income is a hundred thousand dollars. Where you're going to get about a$30,000 reduction or reduction in income right off the bat. Um, so essentially that money. Um, will not be towards your taxable income. Now there are scenarios. And, uh, we talked about this, this, this, and previous. Um, podcast, there are scenarios where you potentially could itemize. Whether that's large contributions to charity or health expenses. Things of that nature. And so, um, now there are some situations where you'll itemize and what that means is you would actually itemize or list out the deductions that you have. So whether that be a student loan, Uh, interest. Let's see. It's your own interest. Uh, Mortgage interest, charitable deductions. Uh, medical expenses, things of that nature of that, all of that adds up to, to be higher than that standard deduction, then you would be able to use that. And so that's what that means by advising. But if that number does not add up to more than a standard deduction, you would just take us into production. And for the vast majority, especially W2 earners. You're going to, you're going to take that standard deduction. Um, For your tax return each year. And number five, the last thing, probably the most, uh, common thing that I see people. Not understand and certainly should understand, uh, if you're a W2. W2 employee and you receive a bonus. Let's say you're making a hundred thousand dollars a year as a base. And. A lot of your income is based off performance and you get bonuses at the end of the year, beginning of the year, where whenever that is, um, let's say you get a$20,000 bonus. That is not taxed, extra. It is just counted as your normal income. Like you got paid throughout the year. Um, the IRS does not see it as anything differently. Now, sometimes your employer. We'll withhold, um, extra. So usually about 22% is the federal mandate. Um, sometimes you can get to them early and say, Hey, don't withhold as much things of that nature. You can change your w four. Um, but the, the bonus that you receive is not tax more. Um, If, if for whatever reason, they withhold more and because of the federal mandate. Uh, and it's more than what you had actually, oh, uh, end up owing on taxes. You would get that back in a tax refund. Right? So, um, again, if you receive a$10,000 bonus, it's not going to be taxed differently. It would re be re it would be taxed at your normal, uh, income bracket. So if you're in the 22% bracket, 24% bracket. That's where that that extra money would be taxed. Um, so. Just remember that sometimes the, the bonus will feel smaller because of what they're withholding. Um, but if they're withholding more than what you'll actually owe at the end of the year, Uh, you'll end up getting that back. Obviously nobody wants to give a loan to the government because they don't pay interest. Um, but, uh, just know that you'll end up getting that money back and see if there's a way that you can have them withholding a little bit less. Uh, if that's a possibility. So, so those are the five basics that I think most people either miss other stand or should definitely know about the tax code and how taxes work. Um, so. Again, bonus. There's bonuses or taxes, normal income. Um, deductions are not a dollar for dollar reduction and taxes. Uh, so be careful, especially if you're a business owner, just purchasing things to get quote unquote, a deduction you're essentially, uh, spending money to get a smaller Mount back or reduced off of your tax return. Um, Capital gains or based off time. Right. Uh, they are not based off, uh, how much you make or things of that nature. They are, but, um, the longer you hold them, the more favorable that tax rate will be. Um, and then taxes are progressive and marginal. So the more you make, the more you will pay. Um, and this is the, to hopefully help people that don't make as much. Um, and the ones that do help out as far as Medicare and social security. As well, so. That is, we'll do it for today. Um, again, I appreciate everybody listening. Hopefully find this helpful. Hopefully, uh, everybody's Thanksgiving was a great one. I had a great time visiting with family and friends, and I look forward to more holidays coming here soon, and we'll be back next Tuesday with a good one. And we'll see you soon. This podcast is for educational purposes only. It is not meant to be financial, legal or tax advice. Please seek a professional about your specific situation. Key Palm valley wealth management in mind when making those considerations.