Unknown: The more money you make, the more you have to pay
in taxes, right? Well, not always. 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.
The rich are different from you and me, as the old saying goes,
in large part because the sources of their income are
different.
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 55 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. On the other hand, 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 and once I tell you,
you're going to get a $10,000 refund, what there is a myriad
of rules, opportunities and options to lower your taxes.
I'll give you a simple example. 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.
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.
And the law is pretty black and white. 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. I
would put forth it's a best practice.
And what I would tell you some of the best practice, not just
high income earners, but any smart savvy taxpayer is to take
advantage of all the tax rules in the law. 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