12 Strategies the Super Rich Use To Reduce Their Taxes
Sure, the wealthy pay taxes (or at least claim to), but they often use legal loopholes and strategies to greatly reduce their tax burden. These tactics frequently take advantage of deductions, business structures, and financial instruments to minimize the amount they owe to the Internal Revenue Service (IRS) each year. Must be nice!
Curious how the rich lower their tax bills? From maximizing “business” expense deductions to stashing money in offshore accounts, here are a dozen common strategies the rich use to make paying taxes a lot less stressful.
1. Opting for Smaller Paychecks
Instead of taking home a sky-high salary, some rich folks opt to receive the bulk of their income in the form of stock options or dividends. This is because this type of income is often taxed at a lower “capital gains rate” compared to higher income tax rates. By reducing their official paycheck, they also avoid high payroll taxes. The luxury!
2. Hiring Family Members
Talk about nepotism. Wealthy individuals often employ their children or other family members in their businesses as a way to reduce their overall tax liability. By paying them a salary, they can then shift a portion of the business income into a lower tax bracket. This means that the income is taxed at a lower rate than if it had remained under the business owner’s higher tax bracket. Genius!
3. Business Expense Deductions
Many expenses that are necessary for running a business — including travel, meals, and even vehicles — can be written off as deductions. This allows the rich to reduce their taxable income by counting personal expenses as business-related. The more expenses deducted, the smaller the taxable income will be.
4. Tax Loss Harvesting
Some wealthy investors strategically sell losing or stagnant investments to offset gains made elsewhere. This allows them to reduce the capital gains tax they would otherwise owe. Stick with us here: They can then reinvest the money, often by buying back the same assets after a short period of time. This allows them to keep most of the profits while lowering their tax bills altogether.
5. Life Insurance Policies
Wealthy and high-profile individuals often use life insurance as a tax shelter by purchasing large policies that grow tax-deferred (meaning the gains on the policy are not taxed as they accumulate over time). After their death, the payout to beneficiaries is tax-free, allowing the deceased to pass on hefty funds without subjecting the recipient to a bloated tax bill.
6. Offshore Tax Havens
Many of the world’s wealthiest move their assets or establish trusts through offshore accounts in countries with low or no taxes. This allows them to defer (or altogether avoid) paying U.S. taxes on their income until they bring it back to the country. Though heavily regulated, these havens remain a common method of tax evasion.
Fun fact: Due to international agreements like the Foreign Account Tax Compliance Act (FATCA), many offshore banks are now required to report U.S. account holders to the IRS. However, some countries may still resist full cooperation, making it a challenge for authorities to track down hidden assets stashed in offshore accounts. Sneaky!
7. Taking Advantage of Pass Through Entities
Creating an LLC, S-Corporation, or other pass-through entities allows business owners to claim business income on their personal tax returns while avoiding corporate taxes. This is because these entities often receive favorable tax treatment, and can benefit from multiple deductions and credits to pay less in overall taxes.
8. Real Estate Depreciation
Property owners can deduct the depreciation of their real estate investments over time, even if the value of the property increases. This reduces the taxable income from real estate investments, which often results in paying little to no taxes on rental income. Taking advantage of real estate depreciation is one of the key tax advantages of owning property. Who knew depreciation could be so beneficial?
9. Charitable Donations
By making large donations to charity, the wealthy can significantly reduce their taxable income by writing off the donations as deductions. Charitable contributions are tax-deductible, and many well-to-do folks create private foundations where they have control over how the funds are used. This not only helps reduce taxes but also builds a philanthropic legacy.
10. Maximizing Trust Funds
Trusts allow the rich to transfer wealth to their heirs while avoiding or significantly reducing estate taxes, which can otherwise take a large portion of inherited funds. By placing assets into a trust, they’re able to reduce the taxable value of their estate when it’s passed on. Some trusts are even designed to minimize or defer taxes to a later date, ensuring wealth remains in the family for generations.
11. Establishing Private Foundations
By setting up a private foundation, the ultra-rich can funnel millions into charitable efforts while receiving tax deductions on business earnings. These foundations typically run on a tax-exempt model, meaning the money deposited into the accounts grows without tax liabilities. Wealthy folks can then maintain control over the assets while reducing their tax burden.
12. Maximizing 401(k) and IRAs
Like everyone else, the wealthy leverage retirement accounts such as 401(k)s and IRAs to defer paying taxes. Contributions to these accounts are tax-deductible, and the money grows tax-free until it’s withdrawn in retirement (early withdrawals are also possible but may incur a penalty). By maximizing contributions during peak earning years, individuals can also reduce their taxable income and lower their overall tax burden.
Wondering what else the ultra-rich spend their money on? We’ve got you covered.