Skip to main content
Tax Strategy

Income Shifting Strategies

Legal ways to lower your tax bracket and keep more of what you earn

Potential Savings
$5,000 - $50,000+/year
Complexity
Intermediate
Professional Required
Recommended
IRS Code Reference
Multiple (see below)
IRS References: IRC 401(k), 403(b), IRC 162, IRC 1(j), IRC 199A, IRC 1400Z

What is Income Shifting?

Income shifting is a legitimate tax planning strategy that allows individuals to legally reduce their taxable income by transferring or distributing income to lower-tax entities or beneficiaries. The goal is to take advantage of lower tax brackets, reducing your overall tax liability while maintaining full compliance with Internal Revenue Service regulations.

Income shifting operates on a fundamental principle: different entities and individuals are taxed at different rates. By strategically moving income to lower-bracket taxpayers or tax-advantaged accounts, you can reduce the overall tax burden across your household or business structure. This differs from tax evasion, which involves illegal concealment of income.

Who Benefits Most from Income Shifting?

Income shifting strategies are particularly valuable for:

  • High-income business owners and entrepreneurs
  • Self-employed professionals (consultants, doctors, lawyers)
  • Real estate investors with substantial income
  • Executives with bonus or commission income
  • Families looking to optimize multi-generational income distribution
  • Partners and LLC members with pass-through income

Individuals earning over $200,000 annually see the greatest benefits, as they're often in the highest tax brackets (37% federal rate) and have more sophisticated income sources to optimize. However, even middle-income earners can benefit significantly from proper implementation.

Step-by-Step Implementation Guide

Step 1: Analyze Your Current Tax Situation

Begin by collecting all income documents: W-2s, 1099s, K-1s, and investment statements. Calculate your marginal tax rate—the rate at which your next dollar of income is taxed. Most taxpayers fail to understand their marginal rate, which is critical for income shifting decisions. For example, if you're in the 32% bracket but could shift income to a family member in the 12% bracket, you'd save 20 cents on every shifted dollar.

Step 2: Consult with Tax Professionals

Engage a CPA or tax attorney who specializes in income shifting and tax planning. They'll analyze your specific situation, identify which strategies are appropriate, ensure compliance with IRC sections 401(k) under IRC 401(k) regulations, and help structure transactions to withstand IRS scrutiny. This professional guidance is not optional—the cost ($2,000-$5,000) easily pays for itself through proper implementation.

Step 3: Implement Retirement Plan Contributions

Maximize contributions to all available qualified retirement plans. For 2024, you can contribute:

  • $23,500 to a traditional 401(k) or 403(b) ($31,000 if age 50+)
  • $69,000 to a Solo 401(k) as self-employed
  • $7,000 to a traditional IRA ($8,000 if age 50+)
  • $18,000 to a SEP-IRA

Each contribution directly reduces your taxable income dollar-for-dollar while building tax-deferred wealth. This is perhaps the most effective and straightforward income shifting strategy available.

Step 4: Claim All Eligible Business Deductions

If you're self-employed or own a business, aggressively pursue all legitimate deductions under IRC Section 162. Common opportunities include:

  • Home office deduction ($5 simplified method or actual expense method)
  • Vehicle expenses (standard mileage rate or actual expenses)
  • Equipment depreciation and Section 179 deductions
  • Professional services and consulting fees
  • Utilities, insurance, and rent for business use
  • Continuing education and professional development

Step 5: Execute Family Employment Strategy

Employ family members in your business, subject to the kiddie tax rules (IRC Section 1(j)). Pay reasonable wages for work performed. Under current law, earned income is taxed at the child's rate, not the parent's rate. This allows you to shift business income to lower brackets while the child builds work history and learns business skills. Key requirements include:

  • Written employment agreement
  • Reasonable compensation aligned with market rates
  • Actual work performed and documented
  • Proper tax withholding and reporting on Form W-2

Step 6: Document and Maintain Records

For all income shifting strategies, maintain comprehensive documentation for at least 7 years. Include employment agreements, investment statements, partnership agreements, gift letters, and contemporaneous valuations. This documentation is critical if the IRS ever questions your strategy.

Real Numbers: Income Shifting Impact

Let's examine how income shifting works with concrete examples:

Example 1: Solo Business Owner Using Retirement Plans

Sarah is a 45-year-old consultant earning $250,000 annually. She establishes a Solo 401(k) through her consulting business. She contributes:

  • Employee deferral: $23,500
  • Employer contribution: $34,000
  • Total contribution: $57,500

Result: Sarah reduces her taxable income by $57,500. At her marginal rate of 32% federal plus 8.82% state tax (40.82% combined), she saves $23,473 in taxes immediately while building $57,500 in tax-deferred retirement assets.

Example 2: Family Business Using Employed Children

Robert owns a digital marketing agency generating $500,000 in revenue. His 16-year-old son assists with social media management. Robert pays his son $10,000 annually for legitimate work performed.

  • Robert's deduction: $10,000 (reduces his taxable income)
  • Son's tax: $10,000 × 10% (standard deduction covers first ~$14,000) = $0 federal tax
  • Robert's tax savings: $10,000 × 37% federal = $3,700 plus state taxes

Result: Income shifts from 37% bracket to 0% bracket. Robert saves approximately $4,200 in combined taxes while his son earns income and builds work history.

Example 3: Qualified Business Income Deduction

Michelle is an S-Corp owner with $400,000 in pass-through income. She qualifies for the IRC Section 199A QBI deduction (20% of qualified business income with limitations).

  • QBI deduction: $400,000 × 20% = $80,000 deduction
  • Federal tax saved: $80,000 × 37% = $29,600

Result: Michelle's effective tax rate on business income drops from 37% to roughly 29.6%. This deduction alone provides substantial tax relief for pass-through business structures.

Advanced Expert Strategies

1. Multi-Generational Income Shifting Through Family Trusts
Establish an intentionally defective grantor trust (IDGT) to shift investment income to lower-bracket beneficiaries. The grantor remains responsible for income taxes while corpus grows tax-free for beneficiaries. This requires sophisticated estate planning but can shift hundreds of thousands in future income.
2. Strategic Roth Conversion Ladder
Perform annual Roth conversions in low-income years to shift future income tax liability to lower brackets. While paying taxes today, you convert pre-tax IRA balances to tax-free Roth accounts, and future earnings escape taxation forever. Most effective in years with reduced income or before higher earning years.
3. Qualified Opportunity Zone Investments (IRC Section 1400Z)
Reinvest capital gains into designated economically-distressed areas under IRC Section 1400Z. You defer the original gain for 5-10 years and potentially exclude gains generated within the fund entirely. This is particularly effective for high-net-worth individuals with substantial realized gains needing deferral and exclusion.
4. Opportunity Zone Fund Structuring
Combine QOZ strategies with C-Corporation taxation for sophisticated income shifting. Profits can be retained and reinvested at corporate rates (21%) rather than individual rates (up to 37%), and strategic entity selection enhances overall tax efficiency across multi-year implementation periods.
5. Charitable Remainder Trust (CRT) Strategy
Fund a CRT with appreciated assets to receive income streams while avoiding capital gains on the appreciation. You get an immediate charitable deduction, shift income recognition across multiple years, and ultimate remainder gifts to charity. Works exceptionally well with concentrated stock positions or real estate holdings.

Common Mistakes to Avoid

Mistake 1: Unreasonable Compensation to Family Members
The IRS closely scrutinizes compensation paid to related parties under IRC Section 162. If you pay your teenage child $50,000 for minor tasks when market compensation is $2,000, the IRS will reclassify excess as non-deductible income. Always ensure compensation matches actual work performed and market rates.
Mistake 2: Ignoring Kiddie Tax Rules (IRC Section 1(j))
Unearned income of children under 19 (or 24 if full-time students) is taxed at parental rates for amounts exceeding $1,250 (2024). Many parents attempt income shifting through investment accounts only to discover the kiddie tax nullifies the benefit. Focus on earned income from employment, which is taxed at the child's rate.
Mistake 3: Inadequate Documentation
Weak documentation invites IRS audits and adjustment. Maintain written employment agreements, timesheets, invoice records, and contemporaneous valuations. If you can't prove the business purpose and substance of your income shifting strategy, the IRS will disallow it entirely, plus impose penalties and interest.
Mistake 4: Aggressive Deduction Claims
Claiming unrealistic deductions on Schedule C invites audit. Many taxpayers overestimate home office deductions, vehicle expenses, or meals and entertainment. Maintain detailed records and stay conservative—a modest deduction that survives audit is better than an aggressive one that's disallowed plus penalties.
Mistake 5: Missing Quarterly Estimated Tax Payments
When you shift income, your income tax withholding may be insufficient. You need to make quarterly estimated tax payments (Form 1040-ES) to avoid penalties. Many self-employed individuals underestimate quarterly payments and owe penalties on top of taxes, negating their income shifting benefits.

Income Shifting Strategy Comparison

Strategy Complexity Tax Savings Potential Implementation Timeline Professional Help
Retirement Plan Contributions Low $5,000-$69,000/year Immediate Recommended
Family Employment Intermediate $3,000-$50,000/year 30-60 days Required
QBI Deduction (IRC 199A) Low $5,000-$30,000/year Annual filing Recommended
Qualified Opportunity Zone High $20,000-$500,000+ 60 days of gain Required
Charitable Remainder Trust High $10,000-$100,000+ 90-180 days Required
Family Limited Partnership High $15,000-$500,000+ 60-120 days Required

Tools and Resources for Income Shifting

Software and Calculators

  • TurboTax Self-Employed - Handles Schedule C deductions and Solo 401(k) contributions
  • QuickBooks Self-Employed - Tracks business expenses automatically
  • Estimate Taxes Calculator - Calculates quarterly estimated tax requirements
  • Tax-Loss Harvesting Software - Coordinates income shifting with investment strategies

Professional Services

  • CPA specialists in business taxation and income shifting
  • Tax attorneys for complex entity structures
  • Financial advisors coordinating retirement and income strategies
  • Estate planning attorneys for trust-based income shifting

Legal Documents Required

  • Employment agreements (family members)
  • Partnership/operating agreements (entities)
  • Trust documents (for trust-based strategies)
  • Loan agreements (for family lending strategies)
  • Business service agreements

Frequently Asked Questions

Income shifting refers to legally transferring income from high-income earners to lower-income family members or business entities to take advantage of lower tax brackets. When done correctly according to IRS guidelines (IRC Sections 401(k), 162, 199A, and others), it's completely legal and a widely-used tax strategy by high-net-worth individuals and business owners.

Potential tax savings depend on your tax bracket and income level. For high earners in the 37% federal tax bracket, shifting $50,000 to a lower bracket (12% or less) could save $12,500 to $18,500 annually in federal taxes alone, not counting state taxes. Actual savings vary based on your specific situation, the strategies chosen, and your state's tax rates.

Common income shifting techniques include maximizing retirement plan contributions (IRC 401(k), 403(b), SEP-IRA), utilizing business expense deductions (IRC Section 162), employing family members in your business, implementing qualified small business stock strategies, structuring investments to defer income recognition, and using Qualified Opportunity Zone investments (IRC Section 1400Z) to defer and exclude capital gains.

Yes, but with strict IRS limitations. You can employ family members at reasonable wages, create family partnerships, establish trusts, or utilize the kiddie tax rules (subject to restrictions under IRC Section 1(j)). All compensation must be reasonable and properly documented. Pay special attention to the kiddie tax rules for minor children—unearned income over $1,250 (2024) is taxed at parental rates.

The kiddie tax rule (IRC Section 1(j)) taxes unearned income of children under 19 (or 24 if in school full-time) at the parents' tax rate above $1,250 (2024). However, earned income and the first $1,250 of unearned income are taxed at the child's rate, creating opportunities for income shifting through employment. This is why employing children in the family business is more effective than giving them investment income.

Income shifting follows IRS guidelines and utilizes legal tax code provisions. Tax evasion involves deliberately hiding income, falsifying records, or misrepresenting facts to the IRS—all illegal activities subject to criminal penalties. The key difference is that income shifting uses legitimate tax strategies with proper documentation, while tax evasion conceals or misrepresents taxable income.

Most income shifting strategies don't have upper income limits, making them accessible to high-income earners. However, some strategies like the Roth backdoor conversion have phase-out ranges. The QBI deduction (IRC Section 199A) has limitations for high-income pass-through owners. Always consult a tax professional regarding your specific income level and which strategies apply to your situation.

Documentation includes written employment agreements for family members, contemporaneous gift letters for transfers, investment account records, partnership agreements, and detailed business expense records. Maintain all records for at least 7 years (IRS can go back 3-7 years in audits, longer for substantial underreporting). Weak documentation invites audit risk and disallowance of deductions.

Yes. A Solo 401(k) allows self-employed individuals to contribute up to $23,500 in employee deferrals plus up to $69,000 total in combined contributions for 2024 (IRC Section 401(k)). These contributions directly reduce your taxable income while building tax-deferred retirement assets. This is one of the most effective income shifting strategies for business owners and self-employed professionals.

A C-Corporation can shift income through reasonable salary payments to owners, corporate expense deductions, and retained earnings taxation at corporate rates (21% vs. individual rates up to 37%). However, double taxation is a significant consideration—income is taxed at the corporate level and again when distributed as dividends. This strategy is suitable for specific situations but requires careful analysis.

The QBI deduction (IRC Section 199A) allows pass-through business owners to deduct up to 20% of qualified business income (with limitations for high-income earners). This effectively shifts income recognition and reduces taxable income for eligible self-employed individuals and business owners. For a business owner with $100,000 in QBI, the deduction would be $20,000, saving approximately $7,400 in federal taxes.

Common mistakes include paying unreasonable compensation to family members (red flag for IRS audit), ignoring kiddie tax rules, inadequate documentation, claiming unrealistic deductions, not consulting professionals, and failing to understand specific requirements of each strategy. Professional guidance is essential to avoid audit risk and ensure your income shifting strategy is compliant and effective.

Review your strategy annually, especially before year-end, to optimize for the current tax year. Tax laws change regularly (IRC updates, bracket changes, contribution limits), and your income situation may evolve, requiring adjustments to maintain compliance and maximize tax efficiency. Working with a tax professional ensures you stay current with changes.

Yes, many successful tax plans combine multiple strategies such as retirement contributions, business deductions, family employment, QBI deductions, and entity structuring. However, each strategy must comply independently with IRS regulations to avoid audit risk. A comprehensive tax plan layers multiple strategies to create compounding tax savings.

Qualified Opportunity Zones (IRC Section 1400Z) allow deferral and exclusion of capital gains through investment in designated economically-distressed areas. By reinvesting realized gains into QOZ funds within 180 days, you defer the original gain recognition. If held for 10 years, the appreciation within the fund is excluded from taxation entirely—a powerful income and tax deferral strategy for high-net-worth individuals.

Your tax bracket is determined by your taxable income level. For 2024, federal rates range from 10% to 37%. Your marginal tax rate—the rate on your next dollar of income—determines the value of income shifting. If you're in the 37% bracket and shift income to the 22% bracket, you save 15 cents per dollar shifted. High-income earners in the 37% bracket realize the greatest benefits from income shifting strategies.

Transform Your Tax Situation with Preston

Join thousands of high-income earners who have optimized their taxes and built lasting wealth through proven strategies. Learn income shifting, tax reduction, and wealth-building techniques in Preston's exclusive programs.

Start the Challenge Today