When Your Income Grows Faster Than Your Tax Strategy

I see it every year. A client calls in March with their documents. Their business had a great year, or they got a significant raise, or they sold an investment. The income went up. The tax bill went way up. And they are wondering what happened.

What happened is their tax strategy did not keep pace with their income growth.

The Problem With Reactive Tax Planning

Most people think about taxes once a year, in the spring. By then, the tax year is closed. Every transaction has already happened. The only question left is how much you owe.

That works fine when your income is predictable and your situation does not change much year to year. But when your income jumps, whether from a new job, a business that took off, or a large investment gain, new tax obligations kick in that you may not have planned for.

Here are some of the common surprises:

You jump into a higher marginal tax bracket. Going from $200,000 to $400,000 in income pushes you from the 32% bracket into the 35% bracket. That is $6,000 more in tax on the same $200,000 increase, not counting state taxes.

You trigger the Net Investment Income Tax. Once your modified AGI exceeds $200,000 ($250,000 married filing jointly), you owe an additional 3.8% on your investment income.

Your estimated tax payments fall short. If your income increased mid-year and you did not adjust your quarterly estimates, you face underpayment penalties on top of the additional tax.

You lose deduction phase-outs. Certain deductions and credits phase out at higher income levels. The itemized deduction for state and local taxes is capped at $40,000 under the OBBB Act, but even that starts phasing out at $500,000.

What Proactive Planning Looks Like

The difference between reactive and proactive tax planning is timing. Here is what we do with clients who have growing or variable income:

Quarterly income projections. We estimate full-year income based on year-to-date numbers and adjust estimated payments accordingly. No more surprises in April.

Mid-year strategy reviews. In June or July, we look at where you stand and discuss moves that need to happen before December 31. Retirement contributions, charitable gifts, equipment purchases, and income timing all come into play.

Entity structure review. As income grows, the way your business is structured matters more. An LLC taxed as a sole proprietorship pays self-employment tax on all net income. An S corporation can reduce that by paying a reasonable salary and taking the rest as distributions. The savings can be $10,000 to $30,000 per year or more.

Investment coordination. We work with your financial advisor to make sure gains and losses are timed in a tax-efficient way. A large realized gain in a high-income year is more expensive than spreading it across two years.

The goal is to make sure your tax strategy grows at the same pace as your income. That does not happen by accident. It happens by planning.

If your income has grown significantly in the last year or two and your tax plan has not been updated, it is worth a conversation. Even a single session can identify opportunities you are missing.