How The Rich Avoid Paying Taxes?

The more money you make, the more you have to pay in taxes, right?

Here in the US, the more you earn, the bigger percentage cut the government withholds from your pay. But here’s the thing, the ultra-wealthy typically take advantage of rules in the tax code, which enable them to lower their effective tax rate. Just take the case of billionaire Warren Buffett. He often points out that he pays less taxes on a percentage basis than his other employees, including his secretary. The reason? Well, most of his wealth comes from his stock holdings, not his annual salary. The great thing about stocks is that you aren’t taxed till you sell them. And even then, the taxes are typically lower than the rates on wage income. So if you ask people, you know, what bothers you most about the tax code, complexity is a common answer, but also the feeling that the wealthy don’t pay their fair share, or the feeling that corporations don’t pay their fair share.

In 2018, Amazon famously pulled in over $232 billion in global revenue, and yet, its federal tax bill was $0. And in fiscal year 2020, at least of the largest corporations in america, including FedEx and Nike, also managed to pay no federal corporate income taxes. There’s a great Supreme Court case with Judge Hand many years ago, that it’s not the taxpayers responsibility to pay the most taxes that he can, it’s the taxpayers responsibility to pay the least taxes that he can. There’s even a rule within the IRS code that if you want to pay more taxes, you can write a check to the United States Treasury, and you can take a tax deduction for that. But some experts say tax breaks are designed to reward the taxpayers who are helping to pump up the economy. Individuals who are not again contributors in terms of real estate and businesses, they don’t get tax benefits, but it’s because they are not contributing to the economic growth at a larger scale.

So how exactly are the country’s biggest earners using the tax code to avoid paying taxes? To understand how the wealthy take advantage of the tax code, you first have to look at where all that wealth comes from. The biggest loopholes arise when you have assets. Most Americans don’t have assets, all they are dependent upon is their income from their salary from their employer. So if you have someone who has assets such as business, and real estate, again, they are unlocking different areas of the tax code that most individuals do not get to explore. you can think of someone’s wealth as being comprised of separate assets which fit into one of three different tax buckets taxable, tax-deferred, and tax free. If your only form of income is your annual salary, then all of your wealth just fits into the taxable bucket. But the rich also tend to diversify into other types of assets and investments that the tax code doesn’t consider to be taxable income. There are individual retirement accounts, some of which are not subject to federal taxes, and then you have investments like stocks that fit into the tax-deferred bucket. If the value of your stock portfolio goes up, you don’t owe tax on those gains until you realize that gain, a.k.a not until you sell that stock. And even when you do so, the tax rate is typically lower than the rates on wage income.

Capital gains can be avoided in life, and also largely avoided in death. And so that’s highly advantageous to high-income, high wealth people. Capital gains taxes also apply to bonds plus tangible assets. So think things like real estate or cars and boats. And with the right tax planning, you can time it such that you only realize those gains during the fiscal year when you have big capital losses to offset that gain. You can also skip the tax entirely if you pass that appreciated portfolio onto your heir when you die. Plus owning property opens up higher earners even more ways to chop down their tax bill.

If you own real estate, you can now deduct things as depreciation, real estate taxes, property taxes. Even if you are not investing in real estate to get rental income, even if it’s your primary residence, you can itemize your tax deductions on a Schedule A which can also lowerly affect your tax liabilities. If you do have rental properties, you can take advantage of depreciation your expense related to your real estate properties and earn some extra income while paying minimal tax on that additional income that you are earning. And these strategies are just the tip of the iceberg. There’s a whole patchwork of ways that can drive down that annual tax bill. There’s not some magic deduction or magic credit that people overlook, you’re going to get a $10,000 refund, what there is a myriad of rules, opportunities and options to lower your taxes. There’s almost 12 different tax breaks for higher education, whether it be the tuition and fees deduction, 529 plans, where you can put money in an account and have it grow tax free.

How The Rich Avoid Paying Taxes?

Borrowing against the value of real estate or borrowing against the value of insurance policies. For example, you can take out a life insurance policy with a high cash dividend, and then borrow against that from a bank. The bank sees that as an actual asset and may loan up to 90% of the value of that life insurance policy. That loan is effectively income to you. But in the tax code, it’s not considered income or a capital gain. So it’s tax free. So there’s these kinds of techniques that can be used if you have a lot of income and a lot of assets, they are just not available to ordinary people that don’t have that kind of disposable income. In 2013, many time Grammy winner Lauryn Hill was sentenced to three months in prison, three months of home confinement, plus a $60,000 fine for not reporting more than $2.3 million in income. She isn’t alone. Some of the biggest names in Hollywood have had serious run-ins with the IRS for failing to pay their fair share of taxes. To be clear, these are all examples of tax evasion, which is illegal, not to be confused with tax avoidance, which is legal, even if it is deemed unfair by large swaths of the population Tax evasion is illegal and is actually punishable for up to 5 or 20 years in prison. There may be some new greyness on things like cryptocurrency, you know, and other new innovations in the world. But most of the time you know it when you owe it. And I can certainly tell whether you owe taxes or not on a situation. But when people come in with fabricated dependence, you know, made-up deductions, phantom partnership losses, that’s when you get into invasion and evasion’s the line crosser. Those sophisticated tax strategies that we just talked about, they are all totally legal ways to avoid paying more taxes than you absolutely must. Tax avoidance, on the other hand, is utilizing the tax code to benefit you in the way that is legal. So if there is a deduction for you having a dependent, or you being able to expend something through a business, as long as you’re following the tax code in the guidelines, you can take these tax positions.

Thanks to lax enforcement by the IRS, tax avoidance by the top 1% of taxpayers could exceed $5 trillion by 2029, according to former treasury secretary Lawrence Summers. This same report found that the top 1% account for about 70% of underreporting. So why is it that the country’s top earners also tend to be pros in the arena of tax avoidance? Experts tell us a lot of it comes down to tax planning. Wealthy individuals tax plan, most Americans don’t have a tax plan. And a tax plan is going to encompass the CPA or tax accountant to go into the new stimulus package or new tax reform and actually look at how they can use the new changes in the code to benefit their clients. These wealthy individuals have that guidance throughout the year to get them to a more reasonable position by year-end. A tax loophole is a provision in the tax code that allows people to reduce their taxes to a point below that intended by the lawmakers. In other words, it’s a technicality that lets the filer avoid a law without directly violating it. Not everyone likes the connotation. Yeah, loophole is kind of a bad word. You know, I’m not even sure what loophole means because it’s either legal or it’s not legal. And if it’s legal, then it’s not really a loophole.

Once embedded in the tax code, it’s pretty difficult to get rid of a tax loophole. Each one not only benefits somebody by saving them money in their taxes, but it also typically has an army of lobbyists backing it up. Sometimes they’re not partisan, because they are more about protecting a given economic sector, or even specific businesses. And that has to do more with the locale. It might be more about what parts of the country, what states, what congressional districts have a certain economic sector that’s very important, Essentially, the US tax system creates an incentivized system for those who aspire to achieve wealth. And here’s why. You get tax credits for having a business or having real estate. In that act, you are creating opportunities to employ people or creating opportunities to house people. Unemployment and homelessness are two of the major concerns for any government. So why not give tax incentives to those who are going to assist in creating a way to aid these issues? So if you close out tax loopholes and tax incentives, we don’t know what the outcome would be, because this can potentially discourage individuals who are contributing to the vast growth of our economy to not make those contributions at a more accelerated rate. Despite the quagmire of opposition, the question as to whether or not to close loopholes often pops up in elections and with new administrations. Just take the Biden White House, the President is taking aim at some pretty popular loopholes in the tax code. Though it remains to be seen whether he’ll succeed

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