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How Wealthy Americans Avoid Paying Taxes

Oct 8, 2020 | Blog

How Wealthy Americans Avoid Paying Taxes

According to the Internal Revenue Service, tax lawyers, and independent researchers alike, rich Americans are the biggest source of underreported income. The National Tax Journal reports that Americans in the top 1% are responsible for approximately 34% of underreported income. According to accountants and tax planning professionals, such individuals sometimes use tax avoidance techniques that are quite sophisticated to maximize their wealth. Although it may seem unfair to many people, this type of tax avoidance is completely legal, as opposed to tax evasion, which is not. Below are the most common tax-avoidance strategies used by wealthy individuals:

Gaining Wealth Through Investments

Taking advantage of long-term capital-gains tax is one way the very rich protect their money. This is because it is far more difficult to avoid paying payroll taxes than taxes on investments. Long-term capital-gains tax is capped at 20%, while 37% is the highest income-tax rate. Therefore, as a general rule, money is safer when only subjected to capital-gains tax.

Reducing Personal Tax Liability with Business Income Loopholes

The 2017 Tax Cuts and Jobs Act allows for a 20% deduction on specific income pertaining to business, such as income that passes through S corporations, sole proprietorships, and partnerships. This is income listed on the person’s individual IRS return, but a reduced tax rate on that money is allowed through the aforementioned tax law. Ultimately, this can reduce the tax rate by as many as 7.4 points. According to the Joint Committee on Taxation, over 60% of the benefits of this loophole go to the super rich.

Asset-Selling Strategies

Timing is everything for the Warren Buffets of the world when it comes to selling certain assets. Taxes on assets such as real estate or stocks do not become due until the assets are sold. This loophole is beneficial to some of the wealthiest people in the country, as they can grow their riches quickly, while avoiding a significant tax bill. In other words, tax burdens are easily minimized when rich investors stockpile assets and wait for strategic times to sell. The Center on Budget and Policy Priorities has stated that wealthy people sometimes wait to sell assets until a year in which they have major capital losses to offset their gains. According to a Federal Reserve analysis in 2013, unrealized capital gains accounted for more than 33% of the assets owned by the wealthiest 1% of American taxpayers.

The Strategic Use of Death-Tax Policies to Increase the Wealth of Heirs 

The United States tax code has long allowed Americans to boost their wealth through deferring capital gains and then passing such assets along to their heirs tax free. This loophole, often referred to as the “stepped-up basis” tax break, inspires those with “old money” to convert as much income as possible into capital gains and keep those assets until death, when such gains become permanently tax exempt.

The amount of a deceased individual’s wealth that can be shielded from estate tax was nearly doubled when the 2017 tax law went into effect. The amount went from approximately $5.5 million to over $11 million, a limit that will reset itself to the previous one in 2025 if Congress does not take action. Those who think their situation may have changed due to these new guidelines or who have questions about their return should contact an experienced tax attorney for advice.

 

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