The $300K Income Tax Trap Most Executives Don’t See Coming

Hello everyone, and welcome back to Fundamentals of Investing. I'm Brian Dress, your host, director of research and advisor here at Left Brain, joined as always by our CEO and chief investment officer, Nolan Langford. Nolan, welcome to the program.

Thank you, Brian. It's great to be here and I can't wait to talk taxes.

It's always the favorite topic. Nolan, we're diving into one of the biggest opportunities and challenges for high-income executives, and that's tax planning once your income crosses the $300,000 threshold. Today, we're breaking down the tax planning levers that matter the most for high earners, and especially those whose compensation includes bonuses, equity, and benefits. That creates a lot of moving parts. And so that's, you know, one of the parts of our practice is helping people plan for those eventualities. Once earnings cross about $300,000, taxes shift from being an annual chore to a strategic lever that you can meaningfully reshape your long-term wealth-building strategy. At this level, your tax bill is often one of your largest controllable expenses. It's larger than your mortgage. It's larger than college savings. It's larger than personal spending. In most cases. And so, for many executives, the complexity is not from them doing anything wrong. It's just the more you get, the more you earn in compensation, you start getting different types of compensation. It becomes very complicated and you could either take it one direction and really take advantage, or if you just let things simmer, it can really hurt you in terms of your wealth building. So, we're going to talk about today in the video, what really moves the needle for high earners in terms of tax planning and how you can turn taxes from a burden into a strategy. So, let's just jump right in here, Nolan. What changes when you cross that $300,000 in income? So, I know you don't know what you don't know. So, as you're building your career, you know, you make $100,000, you move to $200,000, you don't really know what those higher-level executives are dealing with, with taxes. So give some, give some visibility to these emerging executives. What are they missing and what are some of the pitfalls in terms of tax strategy at this level?

So one of the things is you definitely, as you start to climb the tax brackets and the income levels, you certainly have to pay more attention to taxes. So it goes from being in the background to being in the foreground. And what gets ratcheted up is the pain. Yeah. Because you actually start to see some, you know, some 6-figure tax bills.

Right.

And so now it's more top of mind. Mm-hmm. And a lot of people really let taxes kind of be the primary decision maker. We don't certainly want to do that. We want to be balanced, opportunities and taxes. But we know at higher income levels, people definitely pay more attention to taxes. So I would say that's the first thing is the focus shifts. Some of the things that hit people or surprise people when they get higher is, one, you get phased out of your deductions, right? You know, we had a lot of tax regulation changes even after tax— the TRA of '86 that did away with a lot of these personal expenses and limited partnerships or the gas partnerships, all of that. And we used to be able to write off credit card interest and all of that. Those things went away. But if you look at the tax code now, it's very simplified, almost too simplified. And a lot of these higher-level legal deductions are really gone away now. I mean, uh, it, it's really tough to do. But so you have to pay attention to a couple things. One is you are phased out on a lot of legal deductions. Okay. After you hit that level. So things like even your child, Tax credit, right, can get phased out. So you have to really be paying attention. Also, we just brought back the AMT, which is the alternative minimum tax, because for a long time in the tax code, those went away. But with the new tax revisions, AMT is back. So you're going to have to pay attention to not making your situation worse. Okay. So for everybody, this has to be a big deal. And, you know, all of our deductions are capped now with the SALT. State and local tax deductions are capped. So it used to be I could have a house, I'm have a mortgage, and I can write off an unlimited amount of that. And whatever I pay to my state, I got a credit in an unlimited amount to deduct from my federal taxes. That's all been capped. So yep, we really need to pay attention to make sure we don't make our situation worse.

Yeah, that's big in our, in our home state here, Nolan, where we're taping Illinois. One of those states that gets hammered on that SALT deduction issue. So certainly something you got to keep an eye on if you're in one of these high-tax states. Why does complexity increase at these higher income levels beyond the deduction issue?

Well, it also can change how I pay taxes. So I mentioned being a W-2 employee, which means my payroll department in HR is going to do my deductions and send them to my great uncle. Every pay period. But if I'm a 1099 employee or if I'm a gig worker, then that changes. I still have to submit taxes, but I probably have to do it quarterly, which means I probably have to go to an accountant and I'm probably in contact with him throughout the year and I have to send the money to my uncle myself.

Right. Your uncle. And what are some of the common blind spots you're seeing at executives as they cross into this $300,000 threshold?

So I think for most executives, you know, if you're at a publicly traded company or a big firm that's doing HR and payroll for you, a big part of that is equity comp. So think about like a restricted stock unit grant. Generally, the company is going to do the withholding for you. Okay. And everything that you get is net after tax. They'll gross it up, the net will go in shares, and then they'll pay off the top and hold it to your uncle. So at the end of the year, when you're doing your taxes, you know, they're pretty much matched, right? So that's kind of pretty easy. There's not really much for me to do on that side of it. But the other things I really need to pay attention to, for example, a lot of high-income earners may be really encouraged to pay off their house quickly or to pay cash for it. That may or may not make some sense depending on their tax bracket, interest rates, how much cash they have at the bank.

Yeah.

But we know it definitely decreases one of their deductions that they have. Sure. Other things that are simple, like if I'm saving for college for my children, believe it or not, a lot of parents still just, they have a stock portfolio and they're like, yeah, it's gonna cost my son or daughter half, $250,000 to go to college. Yeah. I got a $2 million portfolio. I'll just pay it at that time.

Right.

And you're certainly missing an opportunity and you're not taking advantage of a tax window. So you could do things like, segregate the money, put it in a college account, get a state tax deduction today, have the money go tax-deferred, and then when it comes to college, it comes out tax-free. Right. Versus if I'm in my stock account, I have appreciated securities. Yeah. Now I've gotta sell some of those appreciated securities. So I'm probably gonna trip cap gains and heaven forbid the tuition bill comes due at the same time we're having a correction. It could be a you know, a really bad situation. So I think things like that, I think aren't ideal. Right. And I think from a tax planning standpoint, I think more frequent contact with your financial team kind of makes sense. You don't want a bad surprise to hit you in April, 'cause then you could have taxes and penalties on top of a really big tax bill. Okay.

So let's move to another one. It's income timing and deferral opportunities. So, A lot of stuff with taxes is about timing. And so there are some ways that we can manipulate the timing in which we pay taxes, right? So talk about some of the ways that we can use timing to have an impact on our taxes for high earners and mitigate taxes somewhat.

So I think one of the things you really want to pay attention to is the calendar.

Okay.

So we're in the fourth quarter here, and if I have some transaction that I could do but it's going to create earned income for me in this year. If I have an opportunity to push that to the next tax year, it may be beneficial for me to do it. Yeah, I think the same thing with expenses. If I have deductible expenses and there's something that happens next year that I can prepay because of something this year, maybe I need a higher deduction level this year that can help. And you also want to make sure you don't mess yourself up. Because if it's something that's a transaction that's taxable and taxes aren't being withheld, I could inadvertently accelerate the income, not have the tax withheld, and now I've got a penalty come April. So you, you know, the timing of your transactions need to be really careful. And this is even outside of your brokerage account where you may have realized cap gains and cap losses. Okay.

And then so when you're an executive at this level, sometimes there's years with huge bonuses. Sometimes there's years that you got a bunch of equity vesting or what have you. What are some of the strategies or some of the ways that you think about how to mitigate those type of years?

You— so a couple of things. One, you do not want to make it worse. So we talked about planning early and not waiting to the end. Generally, if some bonus is going to hit, if some equity is going to vest, you know about that. Advance. So you don't want to wait to the last minute. But here's an example. We have a lot of people now. Everybody has a million-dollar home now. I mean, it's very common. I think the average house in America is probably half a million. So to have an executive, to have a million-dollar house is nothing. A lot of these houses are $2 million.

Yeah.

So let's say my executive either moves because he goes from Company 1 or she goes to Company 2, or they just want a new home. So my home was $2 million. I'm going to sell that home and buy another home. Let's say the executive paid $1 million for that home.

Yeah.

So I have $1 million in gain. The government, my uncle, will let me take $500,000 and erase it. Yep. But now I still have $500,000 that I have to pay capital gains on. Yeah. So that in a year where I have a huge bonus, my stock options vest and I exercise and my restricted stock units vest. I may want to think about doing things like maybe I haven't done the deferred compensation plan at work before to a large extent, and maybe I want to maximize that in this year to shelter some income because my income in this year is going to be artificially high.

Smart. Or maybe make that sale in January instead of December.

Right.

Okay. So I think you kind of covered like when we have these vesting events clustering in the same year, really being mindful and understanding and planning ahead of time is really the best bet that you can do. I mean, sometimes you can't avoid paying taxes, but there are certainly some strategies that can be put into place to make it less painful, at least in this year. And so that's certainly something you want to at least reach out to your financial professional or accountant or both and talk about how to plan around that.

One more thing I wanted to bring up before we leave the topic, two things. One is on the home. We just mentioned this home thing. And you're right, if I want to buy home 2 and I know I'm going to trigger a capital gain in home 1, it might make sense to, you know, depending on the time of the year, to wait to a new tax year to sell home 1 or possibly even rent it. The other thing to mention too is yes, we have to pay capital gains, but we all need to remember capital gains are based off our level of income.

Right.

So we either pay it at 0%, 15%, or 20%.

Right.

So I'm up at this level up to $583,000. We're paying at 15%. So if I'm in this year and I know my income is within that $583,000, but next year I'm taking this big job and so my income is going to be higher. Yeah. I may want to take my capital gain in this year.

Yeah.

At 15% versus waiting the future years where it's probably 20% plus the 3.8% additional tax, the surtax on top of there.

So I think what you're saying is, and we're kind of just discussing, is shuffling the deck around a little bit is sometimes what you're doing with tax planning and just being smart about what year you take some of these tax hits. So definitely good, good explanation there, Nolan. Let's talk about tax-advantaged accounts too. So this is definitely a huge part of how to do tax planning. So we understand that Uncle Sam gives us a few opportunities to do some tax deferral, which is in the form of retirement accounts and a few other accounts. So a lot of executives feel like they're already maxing that out. I think when you're at that $300,000 level, a lot of people are already kind of taking full advantage of the 401(k) at a minimum. What else kind of gets overlooked? What are some of the other opportunities? And we hear this term thrown out there all the time, mega backdoor Roth. Is that something that is something is worth considering in this situation?

I think so. I think first for the viewers, we need to kind of talk about the backdoor concept, period. Yeah. In the tax code, they give us an opportunity to do a Roth IRA. And the difference between a Roth IRA and the ones that we're all used to is just the taxability. In a Roth account, I'm actually putting in money that have already been taxed.

Yes.

And so once I put that money in, the rest of the way it should be tax-free. As long as it's a qualified distribution, that money is going to be tax-free for forever. Yeah. The problem is you have to meet certain income thresholds in order to qualify to make that contribution.

Yeah.

And most of the executives that are listening to this video probably don't qualify to just write a check to their Roth because they make too much money.

Exactly.

But there is a backdoor way to make the Roth, which is I can just contribute to an after-tax IRA. Anybody can do that. Jeff Bezos, Elon Musk, they all can do the $8,000 or $7,500 and just to a regular after-tax IRA. Because that money was already taxed, the very next day I can then just convert it to a Roth. And the Roth conversion, because the money was already taxed, will not trigger an additional tax. So that's a backdoor way to do it. Now the limit is $7,500 per year. So it takes a long time for it to add up. Yeah. But there's another way, uh, to do a conversion and a mega backdoor, and These are primarily done through work accounts at work. So a lot of these employer plans, in addition to the 401(k), they'll have a SLEE. They'll let you put after-tax money in the plan. And so let's say I take $10,000 per year for the next 3, 4 years and I put it into my plan. Into year 5, I have $50,000 into this after-tax bucket in my plan. Yeah, I then can just convert that money to Roth.

Yeah.

It's $50,000 at one time, but it's after-tax money. So no additional income to me. But this is another way to circumvent the rules somewhat and get a lot more money in a tax-free account.

So a lot of times that's called after-tax contribution. It may not be called mega backdoor Roth or whatever.

So I'm pretty sure it's like, yeah.

So then that's the thing is like a lot of times we hear these terms thrown out, but A lot of times that's what helps to work with someone who's a professional to kind of walk you through what, how exactly to do these things because it's not immediately obvious. Let's talk about a couple of other topics before we end this out. But charitable, charitable planning is a tax tool, Nolan. So I know a lot of people are charitable givers and, and it's not primarily for the tax benefits, but talk about some of the things that are available to people who are charitably inclined as a way of mitigating taxes?

I'm going to give two. One of them is an external charity. The other one would be an internal charity. So is that the Nolan Langford? Which I'm going to put my account number on the screen and you can just transfer all your shares there. One is if I'm charitably inclined and I have money in an IRA, and I have to take money out of an IRA for whatever reason. A lot of cases it's required minimum distribution that triggers a distribution. So I turn 72, 73, depending on my age, the IRS tells me I need to take $20,000 out of my account. And basically that $20,000 then goes on my 1040 and I have to pay taxes.

Yeah.

Well, instead of doing that and paying taxes, let's say for example, my church, Mm-hmm. I, there's a building fund at the church and I really want to give them some money.

Yep.

I could actually just take the $20,000 from my IRA and give it to them directly. It doesn't go on my, uh, 1040 as income, doesn't hit me in any way, and they get all $20,000, no deduction. And you can do this generally to any 501(c)(3). So your college, university scholarship fund. Sure. Etc. And so we see that a lot. That's a way for you to decrease your income and also increase your charitable giving. It's a good thing. Okay. But there's another way to do this as well. Imagine I have a stock portfolio and I was lucky enough to buy Netflix or Nvidia or Meta a few years ago. And so I have these shares that were $50,000. I only paid $20,000 for them. So I have an embedded unrealized taxable gain of $30,000. Now, if I have kids or grandkids, I can gift them those shares. And now the tax goes from me being in the 37% bracket. If it's my grandkid, they may be in the 0% bracket or my child. So that would be another way to sort of take advantage of taxes and kind of pass it on.

Okay. And then there are also these things called donor advised funds that probably doesn't make sense to go into too much detail, but that's another opportunity there as well.

Correct. So I may want to be charitably inclined, but not necessarily have a charity picked out. I mean, I kind of know I like some, but I need to take some time to think about who really should get this money. Should it be United Way? Should it be the Heart Association? Cancer Association? Not really sure. But by December 31st, I need to do something. So I need to make a transaction. You could put the money in what we call a donor-advised fund, which is a, just a big pool of money. Think about it like a mutual fund for charity. Yeah. I don't have to name the specific charity, but I get the deduction just 'cause I put it in there. Later on, I can decide who the money gets distributed to.

Okay. Last topic I want to talk about, multi-year tax planning framework. So Nolan, I think when people are kind of early career, they just kind of think, what's taxes this year? What are we going to do about that? You just pay it and deal with it. Talk about why one-year thinking is dangerous when you get to this higher level of income. And then, you know, what are some strategies that are kind of multi-year oriented?

So this one is definitely have some hair on it. The reason I say that is, you know, most executives that are mid-career or late career, and let's just say it's a two-income earning household.

Yeah.

Generally over a 5-year period, salaries are not gonna change that much. I mean, except for a person loses a job or decides to start a business. Typically that's pretty sticky. I mean, you can kind of model that out with high level of accuracy. Uh, the things that are more variable where you have control over is what we talked about. Bonuses somewhat.

Yep.

Equity comp, employee stock purchase plan, If I make deferred comp, yep, contributions, all of those sort of things are levers that I can pull in the future. Yeah. And so you're exactly right. I may have some years where my earnings are high, but my expenses are low. Maybe I wanna front load some of these accounts.

Mm-hmm.

And then I may have other years where my income's high, but my bills are high. Like when my kids go to college. Yeah, that might be some time where I want to be distributing money from some accounts that I've put up in previous years when my income was high. So I think the equity piece, or the employee that works for a company where I get equity comp— yeah, those people from a multi-year planning standpoint certainly have a lot more motivation to come see a professional to do some work because they can really take advantage of it if they do it right.

Yeah, I think that's where a lot of the value is with working with a professional like us, Nolan, is, is this multi-year planning. I mean, anyone could kind of just do, you know, pay the taxes as the— as they come on a year-by-year basis. But putting a plan and a strategy in place over a 5 or 10-year period, that's where the value really comes in in terms of mitigating your tax burden.

Especially if you're going to do something that's not vanilla. Like if I'm going to— I have worked for a publicly traded company, me and my spouse, and we're going to stay there till retirement. I mean, there's still some things that we can do. Yeah, but there's a lot of people that are a lot more enterprising. So we see a lot of cases where there is a spouse that's working and another spouse may leave the workforce for whatever reason. Could be stay at home with the kids. Yeah, a lot of times it's to start a business, invest with a business. A college buddy does a startup. Some interesting things like that, you have a, you have an interesting opportunity there because you're going to have, you know, a hill with income. Then you're going to have a valley.

Sure.

That creates a window where you can do some planning opportunities. In a lot of some cases, it's sickness. We've seen cases where somebody may need to take, you know, most of the year off because they were hospitalized or something. So you have an income valley year before it goes back up again. You shouldn't just sit there. I mean, it's a perfect opportunity. Roth conversion. I mean, it's a lot of things that you can do.

So if you've got one of those valleys and you're not working with somebody, definitely reach out. We're happy to see if there's maybe a strategy we can put in place to help you take advantage of maybe a bad situation. So Nolan, thank you for being with us. I want to thank everybody for joining with us. High income tax planning. It's not about scrambling in December or one-off deductions, but it's about creating a structure over a number of years that you could take full advantage of, like you said, the peak years and the valley years. Real opportunities come from coordinating these pieces over multiple years. You know, if we get together on April 14th, we're not gonna make decisions that are gonna help us, but it's all about kind of what can we do about next year, the year after, and the year after that. So high earners, when they shift their mindset from annual tax prep to that long-term tax architecture, that's when you can reduce volatility and increase predictability and creating a foundation for compounding wealth. We don't want to just lower this year's tax bill. It's all about a multi-year strategy. So if you haven't already done so and you're one of these executives that we're speaking with, head over to our website and download the Executive's Guide to Managing Company Stock. If you're in this situation, I'm pretty sure you've got some equity comp. Take a look at what we say about that. We've got a lot of different definitions just to bring you up to speed and then also some ideas of how you can make best benefit of those plans. Thank you, Nolan. Thanks to all of you for being out there. Make sure you like and subscribe and leave a comment answering the question: What tax changes did you make when you became a high earner? We love to engage with you on those sort of topics. We'll see you again on the next Fundamentals of Investing.