Secret Tax Strategies of the Super Wealthy
Recently, ProPublica published an article about “secret IRS files” indicating that wealthy Americans utilize methods to avoid paying taxes. Immediately, it attempts to stoke the flames of class warfare insinuating that people are gaming the system and not paying their fair share.
We encourage everyone to read the article. However, ProPublica concludes that none of the people highlighted appear to have done anything wrong. Instead, they (or their advisors) took the time to read the IRS tax code and structure their assets efficiently.
This seems entirely logical.
The crux of the article is that seven American’s grew their net worth into the billions while paying very little in income taxes. Seven people is hardly a large enough sampling population to derive a meaningful conclusion.
Tax rates and structures are voted on by politicians. The rest of us deal with the consequences. Unfortunately, the tax code is thousands of pages and often has contradictory or opaque rules. Given this, wealthy people have the resources to decipher an overly complicated tax code and use it to make efficient decisions.
Poor people do not have the resources to hire similar tax experts. However, approximately half of American’s pay no federal income tax either. As such, it is true that wealthy American’s pay low tax rates, but they still pay the majority of the tax dollars collected by the federal government.
As such, it is worth offering ten tips for average “non-billionaire” Americans to make their lives more tax efficient.
- Fund a traditional or Roth IRA for you or your spouse. Depending upon your income, this may be tax deductible. Even if you make too much money, a contribution to a traditional IRA still grows in a tax-deferred manner. A Roth does not provide an upfront tax deduction. However, the earnings grow in a tax-exempt manner. The longer you leave it to grow, the greater the benefit.
- Fund a 401k. A traditional 401k can lower your current taxes and grow your savings in a tax deferred manner while a Roth 401k trades the upfront tax deduction for tax-exempt growth. Furthermore, a 401k may benefit from employer matching contributions.
- Make charitable donations. There are many rules when it comes to charitable donations. However, charitable donations are deductible up to 60% of a taxpayer’s adjusted gross income.
- Elderly people who have Required Minimum Distributions can donate all, or a portion, of their RMD directly to a charity. In the process, the distribution is not taxed, and the charity receives the full benefit.
- Losses offset gains. Assume you sold a stock producing a $10,000 gain. You can scour your portfolio throughout the remainder of the year looking for other assets trading at a loss. If you sell a losing position, the loss offsets gains dollar for dollar.
- Let compounding be your friend. In 1987 Warren Buffett added Coca-Cola to the Berkshire Hathaway portfolio between $2 and $3 per share. Today, that asset trades for $55 per share producing more than a 20X increase. And yet, Berkshire has zero taxes on the deferred gain. The capital gains tax is not a tax on gains. It is a tax on the transaction of selling. Choose wisely and trade as little as possible.
- Buy a house and deduct mortgage expenses. Taxpayers can deduct mortgage interest on up to $750,000 in principal.
- A homeowner can take out a home equity loan. This allows them to leave existing assets invested while unlocking cash in an otherwise illiquid asset. Furthermore, the interest paid may be tax deductible.
- Borrow against your taxable brokerage account. If you have “marginable” assets in a taxable brokerage account, your broker can set up the ability to borrow against these assets. As such, this allows you to access liquidity and you can become your own quasi-bank.
- Start your own business. This allows you to run legitimate expenses through the business. These expenses function to lower taxable earnings from the business. In the case of most billionaires, they started a business and continued to invest and reinvest. As they expanded, expenses lower taxable income. If done well, they built value that offered increased employment and value creation while managing their tax bill.
Knowing the rules of the tax code makes logical sense for all Americans. This type of knowledge will not only help make you rich, but it can lower your taxes in the process!