Yahoo Finance Avoid These 8 Tax Mistakes If You’re Rich
People who develop the skill to earn, invest and create a large net worth still make tax mistakes. From not maxing out retirement accounts to neglecting proper estate planning, these errors cost rich people both money and time.
See: Billionaires vs. the Middle Class: Who Pays More in Taxes?
Learn: Owe Money to the IRS? Most People Don’t Realize They Should Do This One Thing
Here are eight key tax mistakes rich people need to avoid if they want to hold on to their wealth.
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Not Maxing Out Retirement Accounts
“Many high-earning individuals do not take full advantage of retirement plans, such as a 401(k),” said Roxanne Hendrix, CPA and JustAnswer tax expert. “Not doing so means missing tax-deferred growth and matching contributions from employers, as well. For 2024, employees can contribute up to $23,000 to a 401(k) and $7,000 to an IRA.”
Next: The 7 Worst Things You Can Do If You Owe the IRS
Not Investing in HSA and 529 Plans
“Like retirement accounts, contributing to a health savings account (HSA) or 529 plan for a child’s higher education can lead to significant tax breaks,” Hendrix said. “HSAs allow you to set aside money for healthcare costs, like doctor’s appointments and medications.
“The HSA contribution limit this year is $4,150 for individuals and $8,300 for families. HSA money goes into the account before taxes — if contributed through the employee’s paycheck — or as a tax deduction for a self-funded account — you can open one anywhere — which grows tax-deferred and can come out tax-free when used for qualified medical expenses.”
She explained, “Money put into 529 plans is tax deductible in some states and can be used to pay expenses such as tuition, books, computers and room and board at a college level or even private K-12 school — depending on the state. Contributions can range up to $500,000 over the life of the 529 account — essentially unlimited.”
Not Understanding Higher Taxation on Bonuses
“An annual bonus makes up a significant portion of many high-income earners’ compensation, but there are two different ways bonuses can be taxed, so it’s important to know which method your company uses,” Hendrix said. “Some companies tax bonuses separately from their regular pay, which means they only withhold 22% in federal taxes. However, high-income earners may be in a higher tax bracket and need to know how their bonuses are taxed and adjust their withholdings accordingly if they are anticipating a high bonus payout.”
Misreporting Backdoor Roth IRAs
“A ‘backdoor IRA’ is a strategy used by high earners whose income exceeds the limit to contribute directly to a Roth IRA,” explained Hendrix. “Instead, they convert a traditional IRA to a Roth IRA, which means paying tax on the conversion but then, afterward, getting to take qualified withdrawals tax-free. This strategy is only beneficial if your future tax rate will be higher than the tax rate at the time of conversion, though.”
Failing To Keep Accurate Records for Charitable Contributions or Itemized Deductions
“Keeping accurate records to prove the legitimacy of filing deductions and tax breaks is the key,” said Hendrix. “This helps to ensure that you can claim all eligible deductions and avoid any potential audits or penalties.”
Investing in Real Estate To Deduct Losses
“Real estate income is a passive income in nature, unless you are a real estate agent working 250 hours a year on managing a single property, which means you can only deduct [passive] real estate… losses to the extent of passive income,” Hendrix said.
Underestimating the Complexity of Their Tax Situation
Richard C. Ford, founder of Hart Accounting Services, said that the wealthy not understanding the complexity of their tax situation is a major pitfall.
“While their income may be high, their financial landscape often involves diverse assets, investments and business interests,” Ford said. “Relying on DIY tax solutions or neglecting professional guidance can lead to missed deductions, overlooked credits and even penalties. Seeking expertise from a qualified tax advisor ensures they navigate the intricacies of the tax code and maximize their legal tax-saving opportunities.”
Neglecting Proper Estate Planning
“Without a well-defined plan, their assets could face unnecessary tax burdens upon transfer, significantly impacting their heirs,” Ford said. “Early consultation with tax and legal professionals helps structure their estate efficiently, minimizing tax liabilities and ensuring their wealth passes smoothly to loved ones.”
Barbara Friedberg contributed to the reporting for this article.
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