Level 6

Solved

Tax Favorable Strategies for High Income Earners

Forum|Forum|4 years ago
November 1, 2021
6 replies
56 views

Good afternoon and Happy November!

Curious the collective wisdom from the group in regards to any possible favorable tax planning strategies for a high income earner who also exercised stock options earlier this year? He is wondering if there is anything he can do to alleviate taxes at this late date. Also, he plans to take about this same amount going forward for the next three years until retirement. He and his spouse both born in 1964. I was considering the admittedly somewhat small impact of (a) possibly adjusting 401k contributions, (b) verifying that he is maxing out any opportunity to contribute to his HSA (c) lump sum 529 deposit for only grandchild? (d) donor advised funds? Any other ideas I am missing? (P.S. Any positive impact is better than none! 🙂

Thank you in advance for any who might have a few minutes to consider the numbers and the dilemma. Approximate numbers taken from last year's tax return:

Box 1 - -508,223. Box 12 - C. 1,336. D. 23,700. DD. 17,726. Box V. 253,925.

Have an amazing Monday,

Dawn .

ProSeries Basic

This topic has been closed for replies.

Best answer by qbteachmt

Tax avoidance isn't always the best goal.

One issue is IRMAA. You mention, "for the next three years until retirement." They are 57 now, plan to retire around 61, and that means they still have 4 years prior to Medicare, and that means managing costs based on the IRMAA table would be one consideration because, "SSA determines if you owe an IRMAA based on the income you reported on your IRS tax return two years prior, meaning two years before the year that you start paying IRMAA." Even if they cannot stay in the lowest bracket, perhaps they can use management tools to avoid jumping to the bottom of a next higher bracket.

https://www.medicareinteractive.org/get-answers/medicare-health-coverage-options/original-medicare-costs/part-b-costs-for-those-with-higher-incomes

To be honest with you, having so much income that this is a problem, then trying to manage 401(k) relative to this, is like digging out a hole and making a pile you later have to dig. Aren't they already maxing this? Sure, deductible retirement is good, now. Not later, though.

They are young enough that non-deductible contributions with tax-free earnings (Roth) would be better, if they have extra to invest, and while backdoor still is an option, I would imagine they have Roth 401(k) as an option. And, they should use some of their funds to make taxable conversions out of Trad IRA/4014(k) and pay that tax now. Then enjoy the tax free growth.

In other words, instead of trying to distribute this into various plans to reduce some proportionate taxes owed, I would use that bonus of found money to start setting myself up to ride into the sunset in a better position. That might mean paying even more taxes now, of course, and clearly, this gives them the headroom for that cost.

And if they have Roth 401(k), they will want to transfer that to Roth when they qualify, to avoid RMD.

And they should give as much as they can to as many programs and functions as possible, because they can.

qbteachmtAnswer

Level 15

Tax avoidance isn't always the best goal.

One issue is IRMAA. You mention, "for the next three years until retirement." They are 57 now, plan to retire around 61, and that means they still have 4 years prior to Medicare, and that means managing costs based on the IRMAA table would be one consideration because, "SSA determines if you owe an IRMAA based on the income you reported on your IRS tax return two years prior, meaning two years before the year that you start paying IRMAA." Even if they cannot stay in the lowest bracket, perhaps they can use management tools to avoid jumping to the bottom of a next higher bracket.

https://www.medicareinteractive.org/get-answers/medicare-health-coverage-options/original-medicare-costs/part-b-costs-for-those-with-higher-incomes

To be honest with you, having so much income that this is a problem, then trying to manage 401(k) relative to this, is like digging out a hole and making a pile you later have to dig. Aren't they already maxing this? Sure, deductible retirement is good, now. Not later, though.

They are young enough that non-deductible contributions with tax-free earnings (Roth) would be better, if they have extra to invest, and while backdoor still is an option, I would imagine they have Roth 401(k) as an option. And, they should use some of their funds to make taxable conversions out of Trad IRA/4014(k) and pay that tax now. Then enjoy the tax free growth.

In other words, instead of trying to distribute this into various plans to reduce some proportionate taxes owed, I would use that bonus of found money to start setting myself up to ride into the sunset in a better position. That might mean paying even more taxes now, of course, and clearly, this gives them the headroom for that cost.

And if they have Roth 401(k), they will want to transfer that to Roth when they qualify, to avoid RMD.

And they should give as much as they can to as many programs and functions as possible, because they can.

Don't yell at us; we're volunteers

BobKamman

Level 15

These why-pay-later-when-you-can-pay-now fans of Roth IRA's always remind me of my client who did a substantial conversion from a 401(k) rollover IRA to a Roth IRA. He invested it in about 1,000 shares of a tech stock trading above $70 a share. This was before the 2008 crash. A couple years later it was below $10 a share. Of course, back then it was predictable that the market would crash. We know that's impossible these days.

qbteachmt

Level 15

"These why-pay-later-when-you-can-pay-now fans of Roth IRA's"

Here's why I'm a fan.

Because a theoretical 30-year old can have $5,000 in either type of account and let's have it double every 7 years on average:

5k at 30

10k at 37

20k at 44

40k at 51

80k at 58

160k at 65

320k at 72

And you would rather pay taxes on each RMD in full, but I would rather pay none and also have no RMD requirement. Remember, either account type, same investment type = same return. And of course I'd rather pay taxes on the $5k, because that taxed contribution is a pittance compared to the end result.

If you do it right.

Don't yell at us; we're volunteers

PATAX

Level 12

In addition to what qb stated you may want to remember the following: last year they made tax law changes in the middle of March and made it retroactive to the prior-year...

BobKamman

Level 15

When you say he exercised stock options, do you mean he exercised and sold? Doesn't think the company has much future once he leaves? There are drawbacks to having too many eggs in one basket, but I would look at ways to hedge if the income is attributable to selling, not just exercising.

N

Norman2001

Level 6

They can look into Qualified Opportunity Funds. I have a client that invested over $200k that would otherwise be taxed at STCG rate. But, always advise researching the funds since they are relatively new investment vehicles.

BobKamman

Level 15

Qualified Opportunity Funds work with capital gains and Form 4797 gains. I don't see any of those here -- it looks like the stock option exercise-and-sales are reported on W-2 forms. If the stock can be held long enough for capital-gain treatment, and the QOZ rules aren't repealed, then that may be worth considering.

SensibleandHourlyAuthor

Level 6

Thank you to everyone who took the time to respond, I appreciate it greatly!!

I would agree that there is much to be said for simply paying the tax now, rather than seeking shorter term deferments that have their own drawbacks and future obligations. We have discussed the advisability of future IRA Conversions in the years after he retires. IF in fact, there are no other changes to the tax code, of course. And, yes, he exercised AND Sold this year, and will for the next three years. I do wish he had been my client many years ago because he is definitely not diversified with industry or account type, but he will be, before we are done. It just might take a few years to get there. 😉

Again, thank you for being other 'sets of eyes' as they say. I find that sometimes I get too deep into a case and can potentially miss the obvious, lol.

Oh, and I will check out the Qualified Opportunity Funds, although, I think that might be a long shot at this point, but good information to brush up on.

Cheers, Dawn

Taxes-by-Rocky

Level 7

With all the uncertainty surrounding Roth conversions, there is one variable that is almost guaranteed: once you pay that tax on the conversion (or salary), you won't ever be getting it back. NOLs are a wonderful thing - sort of - but they're rarely available to most taxpayers. And, in the days when we actually had interest rates, I'd much prefer earnings or appreciation on $10 than on $5. Further, medical costs and nursing home costs have a funny way of approximating those RMDs, potentially reducing or eliminating their tax bite altogether (better yet, providing conversion opportunities to leave the remainder to the kids). While I'm not a fan of the estate tax and would prefer a reduced RMD, I'd certainly rather be diversified (from a tax standpoint) having seen enough to know that the odds aren't always in your favor, or the future as predictable as some might lead you to believe.

BobKamman

Level 15

@Taxes-by-Rocky You hit two nails on the head:

there is one variable that is almost guaranteed: once you pay that tax on the conversion (or salary), you won't ever be getting it back.

medical costs and nursing home costs have a funny way of approximating those RMDs, potentially reducing or eliminating their tax bite altogether

@qbteachmt And another point well-hammered

Paying tax on conversion or paying tax on distribution is the same,

But I don't understand the rest of your observation:

and there isn't as much time for tax free growth

Regardless of the time period, the end result is going to be the same, assuming rates don't change. $100,000 compounded at 5% for x years, times tax rate at distribution, is going to be the same as ($100,000 minus taxes) compounded at 5% for x years.

Which brings up the point that no one here mentions: All the crazy Californians who are doing their Roth conversions before moving to Nevada or Texas, and all the crazy New Yorkers who are doing their Roth conversions before moving to Florida. If we're going to be blind people describing the beast, at least tell us where the elephant is located, and where it might be headed.

SensibleandHourlyAuthor

Level 6

Good Afternoon,

This has been a really helpful and eye-opening thread!
Just for clarity, the client is 57, and would like to retire at 60. It is his understanding that he need to exercise/sell the last of his 600k of stock options before retirement. He has substantial qualified and non-qualified assets as well. (Approx 800k/400k). Spouse has already retired and has approx 100k in qualified assets of her own. They own three homes, with a potential home sale of one of the homes in the next several years- time frame not determined. They have one child and one grandchild. Earned income approx 150k. Looking to be wise over the next few years as they consider all of these moving parts; implications to their retirement, Medicare, future RMDs and ultimately leaving assets to their daughter.

I do sincerely thank each of you for taking the time to comment and share your perspective.

qbteachmt

Level 15

It's a great question, and planning is always a bit of a moving target. The last quarter of the year is a great time to work on these issues. I've had to remind quite a few people to take their RMD this year; they thought that was officially suspended as ongoing.

Too often people realize too late, "Oh, that specific step had to be done by Dec 31, to be included on my April 15 filing?"

Don't yell at us; we're volunteers

Sign up

Login with SSO

Let's get you signed in

Login with SSO