Tax strategies for high W2 income earners

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
TheSunTheSea
Posts: 6
Joined: Tue Aug 06, 2013 7:39 pm

Tax strategies for high W2 income earners

Post by TheSunTheSea »

Hi, I'm a very long time lurker (thanks to everyone for the awesome advice over the years...I've learned a lot)!

I had a question regarding minimizing your tax burden if you have high W2 income. I work in tech and have been fortunate to get a couple of promotions in the last few years. My company pays total compensation in cash (in other words, no RSUs or options). As a result my salary is abnormally higher compared to my peers who get their total comp in cash + stock (I'm making over $700K/year)

The flexibility in what I can do with my income and where to invest it is great, but it also means it's all taxed as ordinary income. I've maxed out my 401K, and I also own a rental property that I'm currently breaking even on (but deduct everything I can from that property, such as mortgage interest, property taxes, maintenance, etc).

For many years I've done my own taxes (hired a CPA a few times but honestly didn't get much value from them). From what I understand, I'm pretty limited with my options since I'm a W2 employee

Are there tax professionals that specialize in my situation? Am I basically limited with what I can do since I get my income from a W2 job? Thanks in advance!
User avatar
FiveK
Posts: 15691
Joined: Sun Mar 16, 2014 2:43 pm

Re: Tax strategies for high W2 income earners

Post by FiveK »

Does your company offer a Non-Qualified Deferred Compensation Plan?
User avatar
TomatoTomahto
Posts: 17100
Joined: Mon Apr 11, 2011 1:48 pm

Re: Tax strategies for high W2 income earners

Post by TomatoTomahto »

TheSunTheSea wrote: Mon Sep 20, 2021 3:07 pm My company pays total compensation in cash (in other words, no RSUs or options). As a result my salary is abnormally higher compared to my peers who get their total comp in cash + stock (I'm making over $700K/year)
Options are another story, but RSUs just show up as W2 income when they vest, so no free lunch. Consider yourself lucky to get cash.

If you discover a simple but effective and legal tax improvement, we are all ears :sharebeer
I get the FI part but not the RE part of FIRE.
jarjarM
Posts: 2502
Joined: Mon Jul 16, 2018 1:21 pm

Re: Tax strategies for high W2 income earners

Post by jarjarM »

Not much opportunities to arbitrage taxes for W2 earners. If you own your primary residence and in a high tax state and still have a mortgage > $750k, consider the following to get a bit more interest deduction.

https://www.svb.com/blogs/mary-toomey/m ... st-expense

DAF and charity donations will help if you incline.
Topic Author
TheSunTheSea
Posts: 6
Joined: Tue Aug 06, 2013 7:39 pm

Re: Tax strategies for high W2 income earners

Post by TheSunTheSea »

FiveK wrote: Mon Sep 20, 2021 3:25 pm Does your company offer a Non-Qualified Deferred Compensation Plan?
Sort of. My company offers a stock option plan, which is different than a traditional ESPP. I can defer pre-tax income to this plan which in turn my company purchases company stock options for me. There's some risk involved in this but it's a very straightforward way for me to reduce my taxable income. It's just that I'm taking a risk in the long term performance of my company (the stock options are good for 10 years)
Topic Author
TheSunTheSea
Posts: 6
Joined: Tue Aug 06, 2013 7:39 pm

Re: Tax strategies for high W2 income earners

Post by TheSunTheSea »

jarjarM wrote: Mon Sep 20, 2021 3:36 pm Not much opportunities to arbitrage taxes for W2 earners. If you own your primary residence and in a high tax state and still have a mortgage > $750k, consider the following to get a bit more interest deduction.

https://www.svb.com/blogs/mary-toomey/m ... st-expense

DAF and charity donations will help if you incline.
Thanks! Is there a general rule of thumb with regards to charity donations and how much to give (e.g. percentage of your income)?
jebmke
Posts: 25271
Joined: Thu Apr 05, 2007 2:44 pm
Location: Delmarva Peninsula

Re: Tax strategies for high W2 income earners

Post by jebmke »

TheSunTheSea wrote: Mon Sep 20, 2021 5:28 pm
FiveK wrote: Mon Sep 20, 2021 3:25 pm Does your company offer a Non-Qualified Deferred Compensation Plan?
Sort of. My company offers a stock option plan, which is different than a traditional ESPP. I can defer pre-tax income to this plan which in turn my company purchases company stock options for me. There's some risk involved in this but it's a very straightforward way for me to reduce my taxable income. It's just that I'm taking a risk in the long term performance of my company (the stock options are good for 10 years)
That is the issue I had with our NQ deferred comp plan. Too much concentrated risk between my salary, bonus, NQ stock options. I elected not to defer my bonus.
Stay hydrated; don't sweat the small stuff
tomsense76
Posts: 1428
Joined: Wed Oct 14, 2020 1:52 am

Re: Tax strategies for high W2 income earners

Post by tomsense76 »

Do you have a HDHP and HSA? Have you maxed out the HSA contribution?

Have you done a Backdoor Roth? While this doesn't shield current income from taxes, this will shield future growth from them.

Does your 401k suport Mega-backdoor Roth? If so, have you filled that up? Same as Backdoor Roth this shields growth from income taxes.

Have you looked at municipal bonds? For high income earners these can be more tax efficient than stocks in taxable as dividend tax rates start to go up (and that's before considering state taxes). One should do the math to see whether they will come out ahead.

Have you looked into savings bonds? These defer income tax on interest until redeemed, are state tax-exempt, and expand one's tax-deferred space. The latter is important as well if one holds a lot of munis and needs more space in one's 401k for stocks (atypical for most, but a reasonable choice for a high income individual).

Generally it's worth your time to understand tax drag on your portfolio, it will be higher than most. So figuring out how to stop the bleeding will help. The above are just a few ways one might do that.

Outside of that yeah it's tough being a highly compensated W-2 employee. At some point it may make more sense to go off on your own and freelance. At least then you can use things like a Solo 401k and contribute both on the employer and employee side pre-tax. Not to mention write-offs for various expenses. Am in a similar boat myself and am trying to decide when it makes sense to pull the plug.
"Anyone who claims to understand quantum theory is either lying or crazy" -- Richard Feynman
jarjarM
Posts: 2502
Joined: Mon Jul 16, 2018 1:21 pm

Re: Tax strategies for high W2 income earners

Post by jarjarM »

TheSunTheSea wrote: Mon Sep 20, 2021 5:29 pm
jarjarM wrote: Mon Sep 20, 2021 3:36 pm Not much opportunities to arbitrage taxes for W2 earners. If you own your primary residence and in a high tax state and still have a mortgage > $750k, consider the following to get a bit more interest deduction.

https://www.svb.com/blogs/mary-toomey/m ... st-expense

DAF and charity donations will help if you incline.
Thanks! Is there a general rule of thumb with regards to charity donations and how much to give (e.g. percentage of your income)?
I don't think there's a rule of thumb per se. It's very much so depends on individuals.
Topic Author
TheSunTheSea
Posts: 6
Joined: Tue Aug 06, 2013 7:39 pm

Re: Tax strategies for high W2 income earners

Post by TheSunTheSea »

tomsense76 wrote: Mon Sep 20, 2021 5:44 pm Do you have a HDHP and HSA? Have you maxed out the HSA contribution?

Have you done a Backdoor Roth? While this doesn't shield current income from taxes, this will shield future growth from them.

Does your 401k suport Mega-backdoor Roth? If so, have you filled that up? Same as Backdoor Roth this shields growth from income taxes.

Have you looked at municipal bonds? For high income earners these can be more tax efficient than stocks in taxable as dividend tax rates start to go up (and that's before considering state taxes). One should do the math to see whether they will come out ahead.

Have you looked into savings bonds? These defer income tax on interest until redeemed, are state tax-exempt, and expand one's tax-deferred space. The latter is important as well if one holds a lot of munis and needs more space in one's 401k for stocks (atypical for most, but a reasonable choice for a high income individual).

Generally it's worth your time to understand tax drag on your portfolio, it will be higher than most. So figuring out how to stop the bleeding will help. The above are just a few ways one might do that.

Outside of that yeah it's tough being a highly compensated W-2 employee. At some point it may make more sense to go off on your own and freelance. At least then you can use things like a Solo 401k and contribute both on the employer and employee side pre-tax. Not to mention write-offs for various expenses. Am in a similar boat myself and am trying to decide when it makes sense to pull the plug.
I'm contributing to an HSA, but haven't explored the backdoor roth. It's pretty popular amongst my peers so I need to look into it. Thanks for the other recommendations, I'll look into it!

As far as going solo, I don't think I'll ever make the kind of money as a freelance contractor as I would being in senior management at a FAANG company. I think I've hit my stride compensation wise. But I could be wrong
User avatar
kingsnake
Posts: 458
Joined: Fri Apr 22, 2011 9:05 am
Location: midwest

Re: Tax strategies for high W2 income earners

Post by kingsnake »

This is what I do...

Max 401k
Max HSA
Max backdoor Roth

Fill 401k with total bond fund
Fill HSA with total stock fund
Fill Roth with total stock fund
Fill taxable account with total stock fund, and the extra bond space I need I use muni fund in taxable

I put 50k into each kids 529 about 6 years back, but stopped contributing after that...

I paid off my mortgage, just don't want to pay the interest

Not much else to do but make less money...which I think I'm going to do if taxes go up even more next year (will take more time off)
tomsense76
Posts: 1428
Joined: Wed Oct 14, 2020 1:52 am

Re: Tax strategies for high W2 income earners

Post by tomsense76 »

TheSunTheSea wrote: Mon Sep 20, 2021 5:59 pm I'm contributing to an HSA, but haven't explored the backdoor roth. It's pretty popular amongst my peers so I need to look into it. Thanks for the other recommendations, I'll look into it!

As far as going solo, I don't think I'll ever make the kind of money as a freelance contractor as I would being in senior management at a FAANG company. I think I've hit my stride compensation wise. But I could be wrong
Yes. Though also look into Mega-backdoor Roth. That will be a bigger chunk of cash.

It's not that clear cut. At $700k, one is paying ~$200k in Federal taxes (a bit more than that actually). Not sure what state tax looks like for you. If CA, in the 11-12% range. So approaching another $100k there. IOW a little less than half of one's income is going to the taxes. Meaning one is only keeping a bit more than half of that pay.

While one may or may not make less running their own business, they can pay significantly less in taxes, which can equate to more after-tax income. For example TCJA included a 20% pass-through deduction for business owners. One can save on FICA with an S Corp (though one is paying both the employer and employee side, one can control what gets counted as salary to some extent). Not to mention one could incorporate outside of higher tax states like CA, which could lower one's cost of living as well. Plus some other benefits.

Should add I'm not an expert on this and am only starting to look into it myself. So am sure other posters will come by and add more details or correct me, which I'm eager to learn from. The point is there can be some advantages to going off and contracting instead of staying at a megacorp.
"Anyone who claims to understand quantum theory is either lying or crazy" -- Richard Feynman
WhiteMaxima
Posts: 3323
Joined: Thu May 19, 2016 5:04 pm

Re: Tax strategies for high W2 income earners

Post by WhiteMaxima »

My company offer before tax non-qualified retirement, but I must maximize IRS $58000 1st before I can take advntage it.
PowderDay9
Posts: 1000
Joined: Fri Oct 12, 2018 12:29 pm

Re: Tax strategies for high W2 income earners

Post by PowderDay9 »

FiveK wrote: Mon Sep 20, 2021 3:25 pm Does your company offer a Non-Qualified Deferred Compensation Plan?
+1

These are great if you want to retire early and have already maxed out all other tax advantaged accounts.
SnowBog
Posts: 4680
Joined: Fri Dec 21, 2018 10:21 pm

Re: Tax strategies for high W2 income earners

Post by SnowBog »

Confirm your 401k contributions are pre-tax. And if/once over 50 take advantage of the "catch up" space.

+1 on other advice.

I'd also look over any "interest" and "non-qualified" dividends you are currently getting, as those are taxed at your income rates. If may be advantageous to switch those to either tax-free options like municipal bonds (maybe split 50/50 between a national fund and a state fund) and/or I Bonds (maybe EE Bonds if useful for your timing/situation) which effectively provide an "extended" tax-deferred space.

If married, make sure spouse is maxing out pre-tax as well (if applicable). Also note you can do a Backdoor Roth for spouse, even if they aren't working (won't lower current taxes, but lessens future taxes).
SnowBog
Posts: 4680
Joined: Fri Dec 21, 2018 10:21 pm

Re: Tax strategies for high W2 income earners

Post by SnowBog »

jarjarM wrote: Mon Sep 20, 2021 5:47 pm
TheSunTheSea wrote: Mon Sep 20, 2021 5:29 pm
jarjarM wrote: Mon Sep 20, 2021 3:36 pm Not much opportunities to arbitrage taxes for W2 earners. If you own your primary residence and in a high tax state and still have a mortgage > $750k, consider the following to get a bit more interest deduction.

https://www.svb.com/blogs/mary-toomey/m ... st-expense

DAF and charity donations will help if you incline.
Thanks! Is there a general rule of thumb with regards to charity donations and how much to give (e.g. percentage of your income)?
I don't think there's a rule of thumb per se. It's very much so depends on individuals.
Obviously DAF amounts align to how much you are giving to charity. Once given to the DAF, it's no longer your money...

The other consideration is this is mainly beneficial when you can deduct the amount from taxes. With the current SALT limits, and the expanded "standard deduction", I've seen recommendations to "group" DAF contributions.

For example, let's say you normally give $10k/year to a charity, that might not be enough to justify doing "itemized deductions". But if you did say 10 years worth ($100k) in a given tax-year, that presumably would let you itemize the charitable deduction. (So you do from getting no tax benefits currently if you are using the standard deduction, to getting occasional tax benefits in the years you donate to the DAF.)

The DAF could still donate annually if you wanted...
SnowBog
Posts: 4680
Joined: Fri Dec 21, 2018 10:21 pm

Re: Tax strategies for high W2 income earners

Post by SnowBog »

Don't think it's been mentioned yet, if you haven't yet, look at Tax Loss Harvesting in your taxable accounts.

Make sure you understand "wash sale" rules.

But any losses you can generate can lower your taxes, offsetting any gains (including dividends) and potentially up to $3k of regular income (with any unused losses carrying over for future years).
gips
Posts: 1752
Joined: Mon May 13, 2013 5:42 pm

Re: Tax strategies for high W2 income earners

Post by gips »

ah, these first world problems :happy

my father had an accounting practice and his advice was to always have a side business which could be used to generate deductions: car, home office, computer, bus travel and entertainment, etc

the advice was given 40 years ago and tax laws have changed in the interim, so definitely check with a cpa. i will say i took his advice, my wife and i had side businesses for about the first 25 years of my career, mostly around our hobbies, they provided significant deductions and, much to my surprise, income.
User avatar
Aslan18
Posts: 40
Joined: Mon Feb 15, 2021 7:55 am

Re: Tax strategies for high W2 income earners

Post by Aslan18 »

gips wrote: Tue Sep 21, 2021 7:01 am ah, these first world problems :happy

my father had an accounting practice and his advice was to always have a side business which could be used to generate deductions: car, home office, computer, bus travel and entertainment, etc

the advice was given 40 years ago and tax laws have changed in the interim, so definitely check with a cpa. i will say i took his advice, my wife and i had side businesses for about the first 25 years of my career, mostly around our hobbies, they provided significant deductions and, much to my surprise, income.
+1
Impossible is a word to be found only in the dictionary of fools. ~ Napoleon Bonaparte
muffins14
Posts: 5432
Joined: Wed Oct 26, 2016 4:14 am
Location: New York

Re: Tax strategies for high W2 income earners

Post by muffins14 »

You absolutely should be doing mega-backdoor Roths. You’re leaving ~$26k-$27k Roth dollars on the table every year that you don’t do this.

I’d also consider your stock option plan as an interesting way to defer compensation. You essentially get to keep pre-tax dollars invested in options for 10 years. Use the calculators your colleagues have for comparing outcomes. You may find that using the stock option plan yields good outcomes even if company stock appreciates more slowly than the market, for example 5% vs 7%
Crom laughs at your Four Winds
RJC
Posts: 1485
Joined: Fri Dec 14, 2018 12:40 pm

Re: Tax strategies for high W2 income earners

Post by RJC »

gips wrote: Tue Sep 21, 2021 7:01 am ah, these first world problems :happy

my father had an accounting practice and his advice was to always have a side business which could be used to generate deductions: car, home office, computer, bus travel and entertainment, etc

the advice was given 40 years ago and tax laws have changed in the interim, so definitely check with a cpa. i will say i took his advice, my wife and i had side businesses for about the first 25 years of my career, mostly around our hobbies, they provided significant deductions and, much to my surprise, income.
Just make sure your business doesn't go at a loss for more than 3 years. At that point it will be considered an expensive "hobby".
LFS1234
Posts: 451
Joined: Fri Feb 08, 2019 3:13 am

Re: Tax strategies for high W2 income earners

Post by LFS1234 »

TheSunTheSea wrote: Mon Sep 20, 2021 3:07 pm ...minimizing your tax burden if you have high W2 income.
Is there a general rule of thumb with regards to charity donations and how much to give (e.g. percentage of your income)?

Here's what has worked for me:

1.

Live beneath your means and invest efficiently and with a long-term perspective. Your salary income may be highly taxed, but this is only the first step in the process. If you let that money work efficiently for you in e.g. a low-cost S&P 500 fund, then you can expect it to grow approximately 8-fold in real (inflation-adjusted) terms over the next three decades, and the taxation of this 8-fold increase is low. The dividends are taxed at a maximum of 23.8%, and the unrealized appreciation isn't taxed at all. This is like a dance where you first take one step back and then 6-8 steps forward. When you're trying to get ahead, this will works very well over time.

2.

Embrace a different point of view. View the IRS as a charity. You're making large, regular charitable contributions by way of the IRS towards lots of worthwhile causes. Keeping the fabric of society running. Medical research. Helping the disadvantaged. You have every reason to be just as proud of these charitable contributions as you would be of any others.

3.

Charitable contributions (other than those going to the IRS): Large donations make the most sense when you easily can afford to make them and you have identified causes/organizations that you wish to support. But first, take care of yourself and those closest to you. The world is full of overfunded 501(c)3s with aggressive fundraisers. Often, the most worthwhile causes are the ones that aren't yet on many radars. Fund what you like, to the extent you wish. But do it because you feel it is a positive contribution to society, not because you're working off of somebody else's checklist. And fund it with donations of highly appreciated stock through a DAF (very efficient), rather than with fully-taxed cash (much less efficient).
User avatar
TomatoTomahto
Posts: 17100
Joined: Mon Apr 11, 2011 1:48 pm

Re: Tax strategies for high W2 income earners

Post by TomatoTomahto »

LFS1234 wrote: Tue Sep 21, 2021 10:54 am Embrace a different point of view. View the IRS as a charity. You're making large, regular charitable contributions by way of the IRS towards lots of worthwhile causes. Keeping the fabric of society running. Medical research. Helping the disadvantaged. You have every reason to be just as proud of these charitable contributions as you would be of any others.
I have 2 little anecdotes about this reframing:

1. My father was not one to enjoy paying taxes, but he paid them to the extent of his legal liability. However, one year when he had had a markedly successful year, he very proudly told me that he had paid as much in income tax that year as he had earned the year before (well, actually two years before). That’s somewhat paying taxes as keeping score, but it’s also an immigrant’s pride in doing his part for his new home.

2. I noticed a marked change in my attitude towards paying taxes since moving from NJ. I don’t want to get political, but I feel much better paying taxes in MA.
I get the FI part but not the RE part of FIRE.
H-Town
Posts: 5876
Joined: Sun Feb 26, 2017 1:08 pm

Re: Tax strategies for high W2 income earners

Post by H-Town »

TheSunTheSea wrote: Mon Sep 20, 2021 3:07 pm Hi, I'm a very long time lurker (thanks to everyone for the awesome advice over the years...I've learned a lot)!

I had a question regarding minimizing your tax burden if you have high W2 income. I work in tech and have been fortunate to get a couple of promotions in the last few years. My company pays total compensation in cash (in other words, no RSUs or options). As a result my salary is abnormally higher compared to my peers who get their total comp in cash + stock (I'm making over $700K/year)

The flexibility in what I can do with my income and where to invest it is great, but it also means it's all taxed as ordinary income. I've maxed out my 401K, and I also own a rental property that I'm currently breaking even on (but deduct everything I can from that property, such as mortgage interest, property taxes, maintenance, etc).

For many years I've done my own taxes (hired a CPA a few times but honestly didn't get much value from them). From what I understand, I'm pretty limited with my options since I'm a W2 employee

Are there tax professionals that specialize in my situation? Am I basically limited with what I can do since I get my income from a W2 job? Thanks in advance!
Did you mean max out 19.5k 401k or 58k after-tax & back-door Roth?

As the Tax Code is currently written, not much wiggle room for W2 employee. The tax could be worse, or get worse...

But it's not material anyways. Just focus on converting the cash into appreciating assets (stocks and real estate). You may pay taxes now, but you can play the long game and build up your portfolio of appreciating assets. You'll get the last laugh.
Time is the ultimate currency.
User avatar
Matahari
Posts: 725
Joined: Sun Mar 08, 2015 3:09 pm

Re: Tax strategies for high W2 income earners

Post by Matahari »

H-Town wrote: Tue Sep 21, 2021 11:14 am
Just focus on converting the cash into appreciating assets (stocks and real estate). You may pay taxes now, but you can play the long game and build up your portfolio of appreciating assets...

+1 on this, in the context of stocks and equities.
So long as capital is taxed at lower rates than earned income, this is a sound strategy and has worked very well for us, over 25+ years.
bslice
Posts: 55
Joined: Thu Dec 11, 2014 11:18 am

Re: Tax strategies for high W2 income earners

Post by bslice »

kingsnake wrote: Mon Sep 20, 2021 6:34 pm This is what I do...

Max 401k
Max HSA
Max backdoor Roth

Fill 401k with total bond fund
Fill HSA with total stock fund
Fill Roth with total stock fund
Fill taxable account with total stock fund, and the extra bond space I need I use muni fund in taxable

I put 50k into each kids 529 about 6 years back, but stopped contributing after that...

I paid off my mortgage, just don't want to pay the interest

Not much else to do but make less money...which I think I'm going to do if taxes go up even more next year (will take more time off)
+1 on this strategy. At some point, it become less complicated if you can max everything listed here (included the Mega Backdoor Roth and Backdoor Roth). Better get it done this year....sounds like thats all about to go away after 2021. I expect the Bill to get passed congress given that one party controls both sides now and the public pressure on "billion dollar Roth IRAs" owned by a few...its a terrible idea to eliminate this.
Post Reply