Reporting large amounts of income on a W-2 form can set up people for a big tax bill, but there are strategies to trim that
A hefty amount of income sounds like a great deal that opens many opportunities, and in many ways, that's absolutely the case.
But when it's time to do taxes, it turns out a high-wage income can be cumbersome, according to financial advisers. In fact, a big income on a W-2 form can be "the worst tax deal in America," as Rachael Camp, founder and owner of Camp Wealth, recently put it on the social-media platform X. She defines a high W-2 salary as roughly $250,000 and above.
"A lot of the incentives you can find in the tax code fall with business owners and sometimes real-estate investors as well," Camp told MarketWatch in an interview, nodding to an array of deductions and credits that can trim tax bills. On the other hand, many of her clients include doctors and consultants, who make their money through salaries reported to the Internal Revenue Service on W-2 forms. They wind up with "high effective tax rates, and there's not many ways to bring that down."
People with wages above $250,000 generally make too much for many tax credits and can't control the timing of their compensation, said Camp. Their pay - like all wage earners - also counts as ordinary income, so it's taxed at a higher rate than investment income.
Compared with other forms of income, wage income "certainly has the least flexibility," said Jon Swanburg of TSA Wealth Management in Houston. "As a W-2 employee, it is what it is - which isn't a bad thing. It just is what it is."
But there is still wiggle room for high-wage earners to save on taxes, Camp and Swanburg noted. The end of the year is a common time for Camp, Swanburg and other advisers to figure that out for their clients.
2025 will be a big year for tax news as lawmakers determine what happens to the federal income-tax code after President-elect Donald Trump's 2017 tax cuts expire. Here's a look at some of the top ways high-wage earners can save money filing their taxes for 2024 and beyond.
Start with retirement accounts - but 'time is of the essence'
Some tax-saving strategies take a lot more planning, Camp said. "We have to look at the return on hassle here and decide if it's worth it." Contributing more to - or even maxing out - an employer-sponsored retirement account like a 401(k) or 403(b) plan is high on Camp's informal metric.
No matter the size of their paycheck, when wage earners contribute to these plans they are lowering their tax bill for the year. It's because the money that would otherwise be counted as taxable income is instead going to a tax-deferred account. It will be taxed when the account holder pulls the money out at a later date.
People can put up to $23,000 in their 401(K)s this year, IRS rules say. People 50 and older can contribute an extra $7,500.
Just avoid a "kneejerk reaction" to stuff excess cash in a 401(K) without thinking about how else the money could be used, said Richard Pon, a San Francisco-based financial planner. Think about whether major upcoming purchases - like buying a home or a child's tuition - would be a better use of the money. "It might hit you in a couple of years," he said.
People who want to take this step should be aware of the time crunch because of payroll administration. They should contact their employers immediately to see if they can increase their pre-tax deferrals in their final paycheck, according to Stephen Dombroski, senior manager of payroll tax and financial compliance at Paychex (PAYX).
The final paycheck for many employers may land on Friday, Dec. 27, for the pay period ending this Friday, the 20th, he noted. "Time is of the essence," he said. Make sure it's processed as a one-time event, which avoids an "unwelcome surprise" of larger deferrals in early 2025 paychecks, Dombroski said.
Some retirement savers can get deductions on their 2024 IRA contributions up to Tax Day next year. However, those write-offs apply under certain income points and also hinge on whether the taxpayer has access to a retirement plan at work.
This year, the IRS says the deduction goes away for individuals after they pass $87,000 in modified adjusted gross income. For married couples, the cap is $123,000.
Charitable giving
The IRS gives a tax break for charitable giving, but people can only use it if they itemize their deductions. While IRS statistics show that 90% of taxpayers use the standard deduction to lower their taxable income, research says the 10% that itemize are typically higher-earning households.
The IRS lets taxpayers deduct cash donations up to 60% of their adjusted gross income. For donations of property gaining value - like stocks - the IRS says the deduction is worth up to 30% of a person's adjusted gross income.
Donating stock doesn't trigger a capital-gains tax for the giver, and the person can still claim the charitable giving deduction, Swanburg said. Donors should be sure they owned the stock for at least a year to maximize the tax-cutting power, he noted.
What if donors want to take advantage of the tax deduction now, but haven't decided where to give? Opening a donor-advised fund is a quick and easy move, Swanburg and Camp said. People can give assets like cash and stocks to these accounts, which major broker firms can easily establish, said Swanburg.
One strategy to get the most from a charitable giving tax break is "bunching," where donations planned for several years are done in one year. A larger amount of donations, combined with itemized deductions like medical bills and mortgage interest, may turn the itemized deduction into a better way to cut taxable income.
Tax-loss harvesting
Speaking of strategic grouping, tax-loss harvesting is the tax-saving tactic where people sell investments at a loss to cut taxes. Capital losses offset long-term capital gains and the tax on those gains are 0%, 15% and 20% depending on the taxpayer's income. When losses exceed gains, up to $3,000 can be used to offset ordinary income and the remainder is applied to future years.
The challenge, in a good way, is spotting specific investment losses when it's generally been a good year for equities. The S&P 500 SPX is up 27% year to date and the Dow Jones Industrial Average DJIA is up more than 15%.
For Swanburg's clients at least, "tax-loss harvesting is kind of on the back burner at this point, but it's something that will be there."
But even if investments aren't currently generating losses, Swanburg said investors may find potential 2024 tax savings from losses in past years. They may just need to dust off those older tax returns first.
When there are still unused losses after taking the capital-loss deduction up to $3,000, the excess is carried forward indefinitely until exhausted.
Many people may not be tracking the balance of their excess losses after taking the initial loss, Swanburg said. "Many people don't even think about it. They hand over the information to their tax accountants and go from there."
Health savings accounts
If employers offer certain health insurance plans, workers can use health savings accounts to cut taxes and plan for future medical costs.
Contributions to these accounts through paychecks are excluded from income and the money someone adds, beyond payroll deferrals, is eligible for a deduction. The money grows tax-free and it's not subject to income taxes when used for qualified medical expenses.
Sounds good, but there's a catch or two. The associated plan needs to be a high-deductible plan. Individuals this year need deductibles worth at least $1,600 and family coverage needs a deductible of at least $3,200, according to IRS definitions of what counts as a high-deductible plan.
More than half of covered workers (57%) were enrolled last year in employer health plans where they paid at least $1,000 deductibles for single coverage, according to KFF and the Peterson Center on Healthcare.
High-deductible plans typically have lower monthly premiums but compared to traditional plans, policyholders need to pay more before insurers pay up.
For Camp, it's the first account she adds to, given the value and tax benefits of an HSA. But taxes aren't everything, which is what she tells her clients contemplating HSA contributions.
"Make sure that you don't let the tax tail wag the dog. If you need better health insurance, go with that," Camp said.
-Andrew Keshner
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.