Developing a financial portfolio of at least $1 million in assets is a great achievement. However, for the individual investor or entrepreneur, the task of maintaining and increasing that wealth calls for some thoughtful tax planning and preparation.

For these ‘high-net-worth individuals’ (HNWI), who number 7.1 million in the United States alone, managing finances isn’t just about keeping the lights on and putting food on the table. It’s about ensuring that every dollar they earn works for them in the most efficient way possible, as well as ensuring compliance with a web of highly complex tax laws.

Today we run through seven solid tax strategies that HNWIs should consider to minimize tax liabilities effectively:

1. Income Deferral

Income deferral allows you to delay receiving income to a later tax year, which can reduce your current tax liability, particularly if you expect to be in a lower tax bracket in the future. For instance, deferring a large bonus or payout to the next calendar year can be advantageous. This strategy is most effective when executed with careful timing, ensuring you manage your tax exposure while retaining more wealth.

2. Strategic Charitable Contributions

Charitable giving is not only a philanthropic effort but also a useful tax-saving vehicle. Donations to qualified charities can be deducted from your taxable income, significantly lowering your tax burden. Additionally, donating appreciated assets, such as stocks, allows you to avoid capital gains taxes while receiving a deduction for the full market value.

The goalposts are constantly changing, however. Since 2018, tax law changes – mostly from the Tax Cuts and Jobs Act (TCJA) – have drastically reduced the number of taxpayers who itemize deductions. One solution is ‘bunching,’ where multiple donations are combined into one year, instead of being spread out evenly over several years.

Gifting $40,000 in a single year instead of $20,000 in each of two years, for instance, may enable a much higher net income tax deduction over that two-year period.

We recommend establishing a Donor-Advised Fund (DAF). These funds, first created in the 1930s but only formally recognized with the Pension Protection Act of 2006, offer much greater flexibility in your giving strategy. They allow you to claim an immediate tax deduction while distributing funds over time.

By 2022, DAF grants accounted for 17 percent of all charitable giving in the United States.

3. Trusts and Estate Planning

For HNWIs, trusts are crucial in estate planning, providing both tax advantages and control over asset distribution. Irrevocable trusts, for example, remove assets from your taxable estate, minimizing estate taxes. The Grantor Retained Annuity Trust (GRAT) is particularly beneficial, enabling the transfer of appreciating assets with minimal gift tax implications.

Using trusts strategically can ensure that more wealth is passed on to your heirs while reducing your estate tax bill.

4. Roth IRA Conversions

Converting a traditional IRA to a Roth IRA can be a powerful move, especially if you anticipate higher future tax rates. Although taxes are paid on the conversion amount at the time, the significant benefit lies in the Roth IRA’s tax-free growth and withdrawals.

This strategy is particularly advantageous during years of lower income or when tax rates are expected to rise, and since Roth IRAs do not have required minimum distributions (RMDs), they allow your investments to grow tax-free for as long as you like.

5. Utilizing Family Limited Partnerships (FLPs)

Family limited partnerships and trusts are an effective vehicle for transferring wealth while maintaining control and reducing estate taxes. By placing assets in an FLP and transferring partnership interests to family members, you can decrease the taxable value of your estate due to discounts for lack of marketability and control. However, FLPs must be carefully structured to avoid IRS challenges, making it crucial to work with experienced professionals.

6. Real Estate Investment Strategies

Real estate investment offers multiple tax advantages, making it an attractive option for HNWIs. One of the key benefits is the ability to take depreciation deductions, which allows you to deduct the cost of the property over its useful life. This can significantly reduce your taxable income even as your properties appreciate in value.

A 1031 exchange helps you to defer capital gains taxes by reinvesting the proceeds from the sale of an investment property into a like-kind property. However, this strategy requires careful planning, as the rules governing 1031 exchanges are complicated. Failing to meet the strict deadlines and requirements can bring serious tax liabilities.

7. Tax-Efficient Investing

Tax-efficient investing is key for HNWIs seeking to make the most of their portfolios while minimizing tax liabilities. Consider investment vehicles that offer tax advantages, such as municipal bonds, which provide tax-free interest income. For HNWIs in higher tax brackets, the tax exemption on municipal bond interest can significantly enhance after-tax returns.

Placing investments in tax-advantaged accounts like 401(k)s, IRAs, or Health Savings Accounts (HSAs) can also lower your taxable income. Contributions are often made with pre-tax dollars, allowing investments to grow tax-deferred. This strategy not only reduces your current taxable income but also maximizes wealth accumulation over time.

There are many more possibilities to consider. Tax-loss harvesting involves selling underperforming assets to offset gains from other investments. Aside from investing, you might also consider tax credits, lifetime gift tax exemptions, and a number of strategies for avoiding capital gains tax and the Generation-Skipping Transfer (GST) tax.

Fulfilling Your Long-term Objectives

In conclusion, effective tax planning for HNWIs clearly demands a multifaceted approach. Regular consultation with experienced tax professionals is essential to adapt to always-evolving tax laws and changing personal circumstances, ensuring that your tax strategies remain effective and properly aligned with your financial goals.

If you need expert assistance to integrate these strategies into your financial plan – to preserve more of your wealth, comply with tax laws, and achieve your long-term aspirations – please get in touch with David’s Family CPA today.