Tax Series, Part Three: Managing Taxes In A High-Income Year – Key Strategies
Managing Taxes In A High-Income Year: Key Strategies To Consider
If you experience irregular income year over year, regardless of the source of these funds, it can be difficult knowing how to plan for these surprises. In my previous blog posts, I have advised on how to plan for this type of tax liability and avoid underpayment penalties when income changes during the year. Aside from paying the adequate amount in quarterly estimated taxes, there are strategies you can implement to help reduce that tax burden when you receive income that you have not planned for.
Strategy 1: Max Out Retirement Contributions
Maxing out your retirement contributions is one of the easiest ways to reduce your taxable income. 401(k) plans and 403(b) plans have the highest contribution limit of any retirement plan your employer may offer. 2025, the annual elective deferral limit for employee contributions will be $23,500. If you are age 50 or older, you can contribute an additional $7,500, bringing the total limit to $31,000. If you are between the ages of 60 to 63, that catch-up jumps from $7,500 to $11,250.
Starting in 2026, catch-up contributions will be treated differently based on income. As of right now, regardless of your income level, all catch-up contributions can be made to regular pre-tax 401(k) and 403(b) accounts. Next year, individuals who made more than $145,000 in the prior year (2025) will have to put their catch-up dollars in a Roth 401(k) / 403(b). This means those contributions will be after-tax, and qualified withdrawals will be tax-free in retirement.
If you are self-employed, you can actually open up an account called a Solo 401(k). To qualify, the only employee you can have is your spouse. The huge advantage here is you can contribute both as an employee and as an employer, which significantly increases your total allowable contributions. In 2025, the combined limit for employee and employer contributions is $70,000 or 100% of the employee’s salary, whichever is lower. Of course, as an employee, you are still eligible for catch-up contributions as long as you are age 50 or older. Additionally, employer contributions can be made up until the businesses’ tax filing deadline (including extensions), depending on your business structure.
Strategy 2: Accelerate Itemized Deductions
If you itemize deductions on your tax return, prepaying certain deductible expenses before year-end can help lower your taxable income in a high-income year. The following examples do not apply if you take the standard deduction on your tax return.
Property taxes / State & Local Taxes (subject to SALT limits)
The deadline for fourth quarter estimated tax payments is January 15th, 2026. However, you can prepay your state and local estimated tax payments before December 31st. You can do the same for property taxes. For all state and local taxes (including property taxes), this deduction is limited to $10,000. So, if you have already reached your limit for the year, it doesn’t make sense to prepay these expenses.
Charitable Giving Through A Donor Advised Fund (DAF)
If you are charitably inclined, utilizing a donor-advised fund account is a great option if your income is much higher than it has been in prior years. Let’s assume you give $5,000 to a specific charity every year. This year, you will earn a large bonus that will bump your income higher or potentially put you into a higher tax bracket. You can open up a DAF account and, for example, contribute $20,000 and receive an immediate tax deduction. This is essentially bunching several years of future charitable giving into one large DAF contribution, and then you can distribute the contributions to charities over several years.
You can deduct the full amount for cash contributions, generally up to 60% of your AGI. For non-cash contributions (stocks, ETFs, mutual funds, etc.), you can deduct the full amount up to 30% of your AGI. Donating stocks that have grown in value also avoids paying capital gains tax on the appreciation.
Business Expenses (if self-employed)
Generally, you cannot deduct prepaid business expenses in the year you pay them. However, if you are a cash basis taxpayer, there is an exception called the 12-month rule. This rule allows you to deduct a prepaid expense in the current tax year if the benefits gained from the prepayment don’t extend beyond the earlier of 12 months from the date the benefit begins or the end of the tax year after the year in which the payment is made. Examples include prepaid rent, insurance, business licenses, and fees. I recommend working with a CPA if this is an accelerated deduction that applies to you.
Strategy 3: 529 Plan Contributions
Contributing to a 529 plan does not reduce federal taxable income, but many states offer state income tax deductions. The state tax deduction for Ohio residents is $4,000 for Ohio 529 contributions per beneficiary per year. You can contribute up to $19,000 per year without impacting your gift tax exemption in 2025. If you contributed $19,000 to a child or grandchild’s 529 plan, the excess amount over $4,000 can be carried forward into future tax years until all contributions are fully deducted.
Let’s say you make two $10,000 contributions to two different 529 accounts for different beneficiaries. You can deduct $4,000 for each account contribution, for a total of $8,000. The remaining $12,000 ($6,000 leftover per account contribution) is carried forward to future tax years until exhausted. Again, this specific state tax deduction is only available for Ohio residents who contribute to an Ohio 529 plans. These state tax deduction benefits will vary from state to state.
Higher income can create higher taxes, but it also creates opportunity. Proactive planning and being aware of your options at hand not only helps the tax burden you face today but also helps keep you aligned with your overall long-term financial goals. Suppose you are unsure which opportunities apply to your situation. In that case, I recommend contacting a financial advisor or a CPA to ensure you are taking advantage of all planning options available.