How to Reduce Taxes on High Earnings

Some tax deductions favor the wealthy.

Creatas/Creatas/Getty Images

In most cases, the taxes you pay directly relate to how much you earn. This can potentially result in a high tax liability for high-income earners. Federal tax rules allow certain deductions that can reduce taxes for high earners. Understanding the tax laws that benefit high earners can help you reduce your taxable income and save money.

Retirement Deductions

Establish a simplified employee pension to deduct contributions. Self-employed, high-income earners who are not currently covered by another retirement plan can reduce their taxable income by starting a SEP. For 2012, you can contribute 25 percent of your compensation or $50,000 ($51,000 for 2013), whichever is the lesser amount. Taking a deduction for your contributions lowers your taxable income substantially and ultimately reduces your tax liability.

Charitable Contributions

The IRS allows you to take a tax deduction of up to half of your adjusted gross income for donations made to charitable organizations, which can result in a substantial reduction in taxes. Deduct charitable donations by filing Form 1040 and itemizing your deductions on Schedule A. You also can deduct the market value of stocks or other non-cash items you donate to a qualified charitable organization. According to the IRS, you must maintain bank records or retain documentation given by the organization detailing your donations.

Investment Interest

You can reduce taxes on your high-income earnings by deducting accrued interest related to investment activities. High-income earners find this deduction especially beneficial because there are no phase-out rules. For example, you can deduct interest accrued on a margin loan you took out to buy taxable investments. The amount of your deduction for investment interest cannot exceed your total amount of investment income. If your expenses exceed your income, you can take a deduction in future years by carrying forward the excess amount.

Capital Losses

Deduct capital losses on investments on Form 1040, Schedule D to reduce the amount of your net income that is taxed by the federal government. According to the IRS, you can deduct your total capital losses from your capital gains, lowering the amount that is taxed at the capital gains tax rate. If your losses exceed your gains, you can deduct up to $3,000 if you are a single taxpayer or married filing jointly, or $1,500 if you are married filing separately. If you realize a net loss greater than the allowable deduction amount, you can carry that loss forward to future years.