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Tax-Aware Strategies for Successful Investors & High-Income Earners
by Kevin Kroskey, CFP®, MBA
Investing is a game of two halves: pre-tax (how your investments perform) and post-tax (what you take home). As they saying goes, “It ain’t over till it’s over.”
While your pre-tax return is partly up to the markets, your post-tax return is more within your control. “Tax-aware” investing means maximizing the fruits of your investing labor by ensuring you don’t sacrifice more of your gains than you have to.
Prime Targets
Those who are financially successful, whether in investing, entrepreneurship, or a career, have more dollars at stake – and the most to lose – in the second half of the game.
A business owner who sells their company for $10m at a substantial gain over its cost basis ($2.5m) can expect to pay one-fifth of the gain ($1.5m) to the IRS in long-term capital gains taxes. Similarly, a company executive who has received stock grants or any investor whose stock portfolio has grown by $1m, would pay the IRS nearly $200k if sold all at once. And don’t forget state taxes too.
Or suppose two specialty doctors who are married. Their wage income alone could be well over $1m. That makes their federal tax rate 37% plus state and local taxes, losing more than 40 cents on the dollar.
Ordinary income (business income, wages, rents, interest, etc.) and capital gains taxes have a similar impact by shaving points off your personal bottom line – just at different rates.
What To Do?
You don’t have to set up shell companies in obscure jurisdictions to try to save on your tax bill (and risk wearing an orange jump suit).
Many investors nowadays take advantage of ‘tax loss harvesting’ to lower their capital gains tax bill. Essentially, if an investment has declined, you can sell it and use the loss to offset a gain. However, this is generally quite limiting. Since markets tend to go up over time, gains generally grow larger via a long-only investing strategy, making tax costs to raise cash or diversify substantial. Plus, capital losses can only offset $3k of ordinary income yearly.
For high-ordinary income earners, pre-tax retirement plans help, but those too are limited by yearly IRS-defined limits. And these are just tax deferral strategies to some future date at an unknown tax rate.
We are accustomed to thinking of gains as good and losses as bad. But this is only taking the first half of the investing game into account. In the second half, we can make those losses work for us to save tax.
What most investors (and professional advisors) don’t know is that you can couple a sound investment strategy with tax-aware trading strategies to succeed in both halves.
This means that our business owner, executive, or successful investor can offset a significant portion or potentially all of their capital gains on their appreciated investment to greatly reduce the tax burden.
It also means our specialty doctor couple could offset their wage income up to $610k (in 2024). Assuming all $610k was saved at a 37% rate, that’s more than $225k in tax savings. Or if this couple were partners in a physician-owned hospital, as an example, they may offset even more than the $610,000, since, as owners, they have business income via a k1.
Surgical Loss-Making
The question is, then, how to generate the losses. By making deliberately poor investing decisions? Hoping for a market crash? Obviously not. There is, however, a way to steadily accumulate losses while expecting to achieve an overall positive return.
The official term for this investment strategy is ‘long-short’. Briefly, there are many types of long-short strategies you can expect to grow wealth. For instance, you may go long a group of highly profitable, growing companies and short a group of unprofitable, stagnant companies.
From a tax perspective, the reason the strategy works is that unlike a ‘long-only’ portfolio (buying and holding a group of stocks like the S&P 500), adding a number of short positions means that, whichever direction the market moves, losses can be realized.
Crucially, not only can these losses be accumulated for tax purposes, but with the right financial instruments and tax-aware trading strategies, tax attributes can be bifurcated between capital and ordinary transactions. Doing so may solve the problems of successful investors or high-income earners.
While these investing and tax strategies are complex, they may deliver significant pre-tax and post-tax benefits at the same time, enabling you to play the broader investing game more successfully down to the final whistle.
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Kevin Kroskey, CFP®, MBA is the Founder of True Wealth Design, a wealth management firm with deep expertise in retirement, tax, and investment planning, helping successful families and individuals Plan Smarter and Live BetterTM
Opinions and claims expressed above are those of the author and do not necessarily reflect those of ScripType Publishing.