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High-Net-Worth Tax Strategies

May 12, 2023

As a high-net-worth individual, managing your taxes can be complex and challenging. However, with the right strategies, you can minimize your tax liability and maximize your wealth. 

Introduction to high-net-worth tax strategies

High-net-worth individuals have unique tax planning needs due to their significant assets and income. Tax strategies for high-net-worth individuals focus on minimizing taxes and maximizing wealth through deductions, investments, and charitable giving. Tax planning should be an ongoing process that considers your current and future financial goals.

Understanding the tax code for high-net-worth individuals

High-net-worth individuals are subject to different tax rules and regulations than the average taxpayer. The tax code provides many tax breaks and deductions available to high-net-worth individuals. For example, the capital gains tax rate for high-net-worth individuals is lower than the regular income tax rate.

To take advantage of these tax breaks and deductions, it is essential to have a thorough understanding of the tax code. Working with a tax professional specializing in high-net-worth tax planning can help you navigate the complexities of the tax code and ensure that you are taking advantage of all available tax breaks.

But if you want to make your life easier, you will spend a few hours a year honing your understanding of capital gains tax advantages. Whether we are speaking of stocks, bonds, mutual funds, real estate, estate planning, or virtually any other sub-category of wealth management, knowing more about capital gains tax treatment makes your life easier and more profitable. 

Capital gains high-net-worth tax concepts

Capital gains tax is your friend. Capital gains is a tax code provision that allows individuals to pay lower tax rates on profits derived from the sale of certain assets. This provision is designed to encourage long-term investment and economic growth by incentivizing investors to hold on to assets for extended periods.

The preferential treatment of capital gains has been controversial in recent years, with some arguing that it primarily benefits the wealthy with access to capital markets. However, proponents argue that it encourages investment and entrepreneurship, which can lead to job creation and economic growth.

Nonetheless, a shrewd understanding of capital gain tax is critical for reaching that next million of net worth.

Under current tax law, assets held for more than one year are classified as long-term capital gains and are taxed at a lower rate than short-term gains. The tax rate for long-term capital gains ranges from 0% to 20%, while short-term gains are taxed at the investor's ordinary income tax rate, which can be as high as 37%.

Capital gains tax is the preferred tax

One of the easiest ways to obtain capital gain is to own stock. Specifically, you need to own stock in an account not tied to some retirement plan. Since this is the case, you would get no upfront income tax deduction for purchasing a stock or stocks. However, any gain you earn is taxed at the capital gains tax rate, not the federal income tax rate.

Note the two tax guides below.

The first tax bracket is the federal income tax bracket.  Let's look at married individuals filing joint returns.

We will call our hypothetical couple Mr. and Mrs. Smith. Mr. and Mrs. Smith had salaries and bonuses of $550,000 last year. By doing so, they have wound up in the 35% federal income tax bracket. Not quite the highest, which is 37%, but pretty close.

Now let's look at this through a different lens. If Mr. and Mrs. Smith had gains in the stock market of $550,000, and no other income to report, they would wind up in a 15% capital income tax bracket. In other words, they pay more than double the tax on earned income than they do on capital gains.

I'll admit I have simplified this to educate you on the fundamentals. However, the fundamentals are still valid. There's nothing wrong with earning a significant income from an employer or a business. But if you want to build substantial wealth under the current tax laws in the United States, it pays to understand how capital gains tax treatment can benefit you.


Source: Vanguard 


Source: Vanguard

It is important to note that preferential capital gains treatment is subject to change based on political and economic factors. Investors should stay informed about changes in tax law and consult with a financial advisor to determine the best investment strategies for their individual goals and circumstances.

Tax-efficient HNW investment strategies

High-net-worth individuals can also take advantage of tax-efficient investment strategies, such as investing in municipal bonds. State and local governments issue municipal bonds exempt from federal income tax. Investing in these types of bonds can provide a tax-free income stream.

Tax-exempt municipal bonds

Municipal bonds, or "Munis," are debt securities issued by state and local governments and their agencies and authorities. They are a popular investment option for individuals seeking tax-exempt income. Municipal bonds come in two primary forms: general obligation and revenue bonds. General obligation bonds are backed by the full faith and credit of the issuer, while specific revenue streams support revenue bonds.

Investing in municipal bonds can provide a steady income stream and diversification to a portfolio. The interest earned on municipal bonds is typically exempt from federal income tax and, in some cases, state and local taxes.

Like all investments, municipal bonds carry risks. The creditworthiness of the issuer, the interest rate environment, and the possibility of early redemption are all factors that can impact the value of municipal bonds. It’s essential to carefully research and analyze the risks and benefits of investing in any particular municipal bond before purchasing.

Overall, municipal bonds can be a valuable addition to an investment portfolio for those seeking tax-exempt income and diversification. As with any investment, you must do your due diligence and consult a financial advisor to determine if municipal bonds suit you. 

Tax-managed funds

Another opportunity we will look at is tax-managed funds. Often, we see clients with large 401(k)s or other retirement savings vehicles but very little in non-retirement accounts. If you have already topped out your 401K savings for the year, consider placing any remaining into a tax-managed fund. While you would not get any tax benefit up front, the tax advantages over time can be just as compelling as your retirement accounts--albeit in a very different way!

Tax-managed funds are mutual funds designed to minimize the tax burden on investors using various tax-saving strategies. These funds are managed to minimize the tax impact of the investments made by the fund. They are instrumental for investors who are looking to maximize their after-tax returns.

There are several ways in which tax-managed funds can be structured to minimize taxes. One approach is to focus on long-term investing. By holding investments for a more extended period, tax liabilities can be reduced. Another approach is investing in securities that generate lower taxable income levels. This can be achieved by investing in tax-free municipal bonds or stocks that pay lower dividends.

Tax-loss harvesting

Tax-managed funds also use tax-loss harvesting strategies. This involves selling securities that have declined in value to offset gains elsewhere in the portfolio. This reduces the tax liability on the overall portfolio. Tax-managed funds may also use strategies such as index tracking, which involves investing in stocks that are part of a broad index, to minimize taxes.

One of the main benefits of tax-managed funds is that they can provide higher after-tax returns compared to traditional mutual funds. By minimizing tax liabilities, these funds can help investors keep more of their investment gains.

However, tax-managed funds also have some drawbacks. They often have higher expense ratios than traditional mutual funds. Additionally, these funds can be less diversified than other mutual funds, as they may focus on specific sectors or asset classes to minimize taxes.

Investors need to consider the tax implications of their investments carefully. Tax-managed funds can be a good option for investors looking to maximize their after-tax returns. However, investors should also consider the fees and restrictions associated with these funds before making a decision.

Pitfalls: NIT, AMT, and state tax

This next section is on the pitfalls of poor tax planning. The three areas that I see people making the most mistakes are the following:

  1. Net investment income tax
  2. State income tax
  3. Alternative minimum tax

These taxes are so tricky because they are in addition to regular capital gains or federal income tax. The more money you make, the more the government wants to extract. And mistakes can be costly!

High-worth individuals should avoid several common mistakes when managing their taxes. One mistake is failing to plan for taxes. Tax planning should be an ongoing process that considers your current and future financial goals.

Another mistake is failing to take advantage of available tax breaks and deductions. High-net-worth individuals can take advantage of many tax breaks and deductions. Still, it is essential to understand the tax code and work with a tax professional to ensure you maximize your deductions.

It is always a good idea to consult a financial advisor before making investment decisions.

Net investment income tax (NIIT)

The Net Investment Income Tax (NIIT) is a 3.8% tax on certain types of investment income that the Affordable Care Act introduced. It applies to individuals, estates, and trusts with income above certain thresholds. The types of income subject to NIIT include interest, dividends, capital gains, rental and royalty income, and passive business income. However, it does not apply to income from active business activities or retirement income. The purpose of the NIIT is to provide funding for the Affordable Care Act. Taxpayers must understand the NIIT rules and how they may affect their tax liability.

State income tax

State income tax is a tax imposed on the income of individuals within a particular state. High-net-worth individuals (HNWIs) have significant disposable income and assets. As such, HNWIs are often subject to higher state income taxes than other taxpayers.

State income taxes vary from state to state and are calculated as a percentage of an individual's income. Generally, states with higher income tax rates also have higher tax brackets, meaning HNWIs are likely to pay a larger share of their tax income than lower-income earners.

State income tax can be a significant burden for high-net-worth individuals. With the highest marginal tax rates reaching as high as 13% in California, wealthy individuals can face a substantial tax bill each year. However, some strategies can be employed to minimize the impact of state income tax.

One approach is establishing residency in a state with no income tax, such as Florida or Texas. This can be accomplished by spending the majority of the year in that state and establishing other ties, such as a primary residence and voter registration. However, knowing the rules and regulations surrounding residency requirements is important, as states may challenge attempts to change residency for tax purposes.

HNWIs may also be subject to additional state taxes, such as estate, property, and sales taxes. These taxes can add up quickly and significantly impact an individual's overall tax burden.

To minimize their state income tax liability, HNWIs may engage in tax planning strategies, such as investing in tax-advantaged accounts, taking advantage of deductions and credits, and working with a tax professional familiar with the nuances of state tax laws.

Overall, state income tax is an important consideration for HNWIs, as it can significantly impact their overall tax burden and financial planning strategies. As such, HNWIS need to stay informed about the tax laws in their state and work with a knowledgeable tax professional to minimize their tax liability.

North Carolina state income tax

I live in North Carolina, with a relatively reasonable state income tax.

North Carolina is a state that levies a state income tax on its residents. When this was written, North Carolina State income tax was about 4.75%. North Carolina also allows for deductions and exemptions, which can help reduce the amount of income subject to taxation.

It's important to note that North Carolina's state income tax is just one component of its overall tax system. Other taxes imposed in North Carolina include sales, property, and excise taxes. Each of these taxes can significantly impact an individual's overall tax burden.

It's also worth noting that North Carolina's tax laws and rates are subject to change over time. As such, state residents must stay informed about any changes to the tax code that may affect their finances.

Alternative minimum tax (AMT)

The Alternative Minimum Tax (AMT) is a parallel tax system in the United States designed to ensure that high-income taxpayers pay a minimum amount of tax. It was introduced in 1969 to prevent wealthy individuals from avoiding taxes through deductions and credits. The AMT has rules for calculating taxable income and applies a higher tax rate than the regular income tax system. Taxpayers must calculate their tax liability under both systems and pay the higher amounts.  

The Alternative Minimum Tax (AMT) is an additional tax that high-net-worth families may face in addition to their regular income tax. The AMT is designed to ensure that individuals with significant deductions and credits still pay a minimum amount of tax. However, the AMT can significantly burden HNW families as it often substantially adds to their overall tax liability. To minimize the impact of the AMT, HNW families may engage in tax planning strategies, such as investing in tax-free municipal bonds, engaging in charitable giving, and working with a knowledgeable tax professional.

Real Estate Hypothetical

Maybe you are selling a piece of real estate. If so, have you determined the tax circumstances upon liquidation? Are there any other taxes you would pay besides capital gains tax? For example, let's say you sold a $3,000,000 piece of property with a $1,000,00 basis and a $2,000,000 gain. What would the taxes be?

Does the state you're living in impose a tax in addition to capital gains on properties sold in its domicile? If you're in a state like North Carolina, you could pay an additional state tax of about 5% on such a sale. You may pay double that if you're in a state like California. Remember that these taxes might be in addition to, not instead of, the capital gains tax.

Under current tax laws, you must also be aware of net investment income tax(NIIT). Like state tax, this tax is typically in addition to capital gains on the sale of real estate. This tax is roughly 4%. Net investment income tax applies to individuals, estates, and trusts and usually targets passive stock options, business income, capital gains,  dividends, etc.

Stock Option Hypothetical

You may have some stock options coming due. If so, have you determined the tax circumstances upon liquidation? Have your CPA run a mock tax set to ensure you understand these implications?

Often with stock options, an individual receives two or three payments over two or three years. You work a certain number of years and then receive $1,000,000 per year for a total of $3,000,000.

How are stock options taxed? Are they also subject to net investment income tax or state income tax? It would be best to ask these questions to avoid the pitfalls of poor tax planning. It would be best to study them independently and run them by a qualified accountant or CPA to ensure you are getting the math right.

For the sake of brevity, we won't even get into alternative minimum tax except to say that you need to be aware that it's another overlooked component of high-net-worth tax planning.

Taking control of your high-net-worth taxes

Managing your taxes as a high-net-worth individual can be challenging, but with the right strategies, you can minimize your tax liability and maximize your wealth. Understanding the tax code, developing a comprehensive tax plan, and working with a financial advisor can help you achieve your financial goals and take control of your taxes. By implementing these high-net-worth tax strategies, you can maximize your wealth and secure your financial future.

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To learn more about high-net-worth tax strategies and how they can benefit you, contact our team of financial advisors today. We can help you develop a comprehensive wealth management plan considering your current and future financial goals.

The Importance of Working with a Financial Advisor

Managing your taxes as a high-net-worth individual can be complex and challenging. Working with a financial advisor specializing in high-net-worth tax planning can help you navigate the complexities of the tax code and ensure that you are taking advantage of all available tax breaks.

A financial advisor can also help you develop a comprehensive wealth management plan considering your current and future financial goals. They can help you identify tax-efficient investment strategies, develop an estate plan, and manage charitable giving. Speak with a financial professional TODAY