When you earn more, you tend to owe more — at least to the IRS. That might inspire you to search for creative tax loopholes, but those strategies don’t always go as planned.
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A money-saving move that sounds great on the surface could actually increase your tax bill. Keep reading to discover five tax hacks high earners probably shouldn’t rely on.
Expecting Tax Savings From Real Estate Investments
It’s not uncommon for wealthy people to invest in real estate, but without proper guidance, they can face tax issues, said Lawron Ballard, certified public accountant (CPA) and CEO at Hill Town Advisors. She said clients often assume real estate investments will lower their tax burden, but the losses those investments generate typically don’t lead to substantial tax savings.
“That’s because there’s something called passive loss limitations, and when you’re not a full-time real estate investor, those losses are limited to passive income,” she said. “Anything over that is locked away until you sell.”
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Timing a Backdoor Roth IRA Execution Wrong
Income limits make many high earners ineligible for a Roth IRA. As a result, some convert traditional IRA contributions into a Roth IRA — i.e., a backdoor Roth IRA — Ballard said.
“The problem is that if it’s done at the wrong time, it actually ends up costing you more than it saves you,” she said. “The key to making Backdoor Roths work is to time the conversion with when your income is lower.”
For example, that could occur during a period when a spouse is out of the workforce or after retirement, but before required minimum distributions (RMDs) are triggered, she said.
Creating a ‘Side Hustle’ LLC, Essentially for Personal Spending
It’s not uncommon for wealthy individuals to set up a limited liability company (LLC) and use it to write off all their personal expenses, often because of social media, said Deltrease Hart-Anderson, an IRS enrolled agent at D Hart Accounting Practitioner, LLC. This can trigger the IRS to audit the LLC because it takes constant losses or generates little to no income.
Consequently, the IRS may treat the LLC as a hobby, disallow deductions and put the taxpayer on its radar, she said.
No Documentation for Charitable Donations
Generous high earners might contribute to a donor-advised fund, donate goods to a charitable organization or give a vehicle to a nonprofit. However, without proper documentation — such as proof of donation, a vehicle appraisal or fair market value of donated items — the claimed value can be reduced or denied, Hart-Anderson said.
Assuming Moving to a No-Tax State Means No Tax Bill
“Remote workers and traveling executives get hit with state [tax] issues,” said Hart-Anderson.
People may think moving to a state with no state taxes makes them exempt from paying all state taxes, but that might not be the case, she said.
“If the taxpayer still keeps strong ties to their old state, owns property in their old state, and driver’s license is still at the old state’s address, then that state will deem you a resident,” she said. “If the old state catches up with you — and most will — there will be back taxes owed to include penalties and interest.”
Ultimately, the IRS doesn’t care where you reside, but each state wants their slice of the pie, she said.
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This article originally appeared on GOBankingRates.com: High-Income Earners: These 5 ‘Tax Hacks’ Could Backfire During Tax Season
