My spouse got the dreaded letter in the mail the other day...the one that tagged my spouse as a "highly compensated employee". I disagree with that designation, but I digress. What this means is a 10% cap on what can be funded into the 401K which falls well short of the $17000 allowed for everyone else thanks to average company contributions. My plan was already funded to the max. also. It appears that we also exceed the phase out limits for the Roth and we also lost the child tax credit. We also built a home last year and moved in in May which helped our tax bill a lot. But its looking like we still owe about $2K. The additional interest on the mortgage and the additional property tax bill will help fill the gap this year, but we lost a lot too because of the HEC letter. I've been searching for other methods of legally reducing our federal tax liability (no state income taxes here). Short of drastically increasing our charitable contributions or adding on a pool (which I DO NOT WANT), I'm coming up empty. I'm hoping some of you smart folks have some ideas.

Welcome to the world of 'high income'. Yes, taxes do get higher as your earnings increase. In your case I suspect this is something you'll just have to get used to. Keep in mind, that wasting a dollar to save $.28 doesn't make much sense, so I would carefully consider any 'tax savings' expenses you make to make sure its an expense you'd likely be making anyway.

You could ask your employer to consider adopting a safe harbor 401(k) or a Qualified Auto Contribution Arrangement 401(k), which would allow the HCE's to max out annual contribution limits. But often, particluarly employers with lots of non-HCE's, these may cost him/her a bit more in mandatory matching or non-elective contributions and so may not want to do this, but it might be worth asking.

You can certainly contribute to your traditional IRAs up to the max of $5,000 each ($6,000 if 50 or older in 2012). This would not be deductible but earnings would be tax deferred.

BruceM

ferjen: "I've been searching for other methods of legally reducing our federal tax liability (no state income taxes here). Short of drastically increasing our charitable contributions or adding on a pool (which I DO NOT WANT), I'm coming up empty."

I am not sure what adding a pool does to reduce FIT.

Given that reducing FIT liability seems to be the driving force, you could lend my SPE any amount you wish, payable at matruity on December 30, 2012, and when the SPE fails to pay, have a bad debt write-off that should reduce you for FIT liability. (;>)

I have another sure-fire method of reducing FIT liability, but I am not inclined to give it away today.

Regards, JAFO

PS - You should enjoy your "misfortune"; a lot of people would be happy to trade for your "problems".

I am not sure what adding a pool does to reduce FIT.

The pool would be done with a second mortgage, and that interest would be deductible. But, as the previous poster stated, spending a dollar to save 28 cents makes no sense.

I agree this is a good problem to have, but it came on quite suddenly and I'm not experienced in how to deal with it - particularly to not get stuck writing a big check to the feds next year.

Had we known last year, we'd have bumped up our flexible spending account a bit, especially with braces in our near future. :-) There's always next year...but what to do this year? Hmmmmm....

Hopefully, the additional five months of mortgage interest payments and the increase in property taxes will be enough to square us up...

I just want to make sure I'm not missing anything...

I'm not experienced in how to deal with it - particularly to not get stuck writing a big check to the feds next year.

Increase your withholding.

Welcome to the 1%er club. You now have a target on your back. Now back to work, there are thousands of OWSers that are depending on you.

There are tax deffered bonds to consider. Master Limited Partnerships which throw off high dividend rates but have favorable tax treatment (for now). Just because you've been phased out of a Roth, don't forget to contribute to a traditional IRA, at least things grow tax deffered.

Save in a regular brokerage account as well. You're getting to the point where you'll have a little bit in several different types of accounts. It is an advantage, you won't get the best tax treatment but you won't get the worst either.

And remember, rules change. IMHO, when the majority of Americans start withdrawing from Roth IRAs in the future, BAM, federal sales tax.

JLC

I am not sure what adding a pool does to reduce FIT.

I was guessing second mortgage or home loan where interest was deductable.

JLC

Had we known last year, we'd have bumped up our flexible spending account a bit...

Have you checked into an HSA account? You don't have to spend the money, rolls over from year to year and can act as an "extra" retirement account if you're healthy and you've accumulated money.

JLC

I've had to start writing a check every year due to investment income. I love it. I'd rather owe more taxes and have more money than the alternative.

But, the right answer is to increase your withholding.

D.

"Have you checked into an HSA account? You don't have to spend the money, rolls over from year to year and can act as an "extra" retirement account if you're healthy and you've accumulated money."

JLC

An HSA can only be contributed to if one is not currently covered by health insurance. Although the OP doesn't say, at this level of income, it would be unusual for the employer not to offer health insurance.

BruceM

>> An HSA can only be contributed to if one is not currently covered by health insurance. <<

Huh?

Contributing to an HSA absolutely *requires* that you have a qualified, HSA-eligible high deductible health insurance plan. No health insurance, no HSA contributions.

#29

An HSA can only be contributed to if one is not currently covered by health insurance.

No. Not even close.

To contribute to an HSA, you MUST have a health insurance policy that qualifies you to make the HSA contributions. They call it a High Deductible Health Plan (HDHP), but there's a lot more to it than just a high deductible.

--Peter

On Traditional IRA's, I'm not sure we can contribute to those either because of the phase out rules. A lot of your other good suggestions we will have to wait until next year because we can only make those changes during open enrollment.

On Traditional IRA's, I'm not sure we can contribute to those either because of the phase out rules.

If you have earned income, you can make a traditional IRA contribution. The phase out rules only limit how much of the contribution you can deduct.

--Peter

If you have earned income, you can make a traditional IRA contribution. The phase out rules only limit how much of the contribution you can deduct.

Got it. Then, is there an advantage to funding a Traditional IRA vs. just using a cash brokerage account?

ferjen: "Got it. Then, is there an advantage to funding a Traditional IRA vs. just using a cash brokerage account?"

Plus, no taxes on gains in the account until withdrawn.

Negative, ordinary income tax rate when withdrawn (at some futhre unknown date and rate), versus potential for LTCG rates in a non-IRA brokerage account.

Regards, JAFO

JAFO31 posts,

<<<ferjen: "Got it. Then, is there an advantage to funding a Traditional IRA vs. just using a cash brokerage account?">>>

Plus, no taxes on gains in the account until withdrawn.

Negative, ordinary income tax rate when withdrawn (at some futhre unknown date and rate), versus potential for LTCG rates in a non-IRA brokerage account.

</snip>

You also get some liability protection by having your assets in an IRA since most states won't attach a retirement account to satisfy a court judgement.

intercst

"Contributing to an HSA absolutely *requires* that you have a qualified, HSA-eligible high deductible health insurance plan. No health insurance, no HSA contributions"

No.
A personal HSA to which one may contribute pretax dollars (the objective of the OP) is, by definition, made of two components: a custodial HSA and a HDHP. This is by definition.

If one is already covered by a health plan from their employer or their spouses employer, as I'm sure the OP is, then they are not eligible to contribute to a personal HSA.

BruceM

In same situation, carry family plan in retirement. I don't need as a 100% disabled vet have full med. at VA or VA pay if they can't. So Don't need family plan. you are paying higer cost family coverage. That is paid insurance.