More than $160 billion in tax revenue is lost every year because the top 1% finds ways to avoid paying “their fair share,” according to academic research cited by theTreasury Department.
What tactics, though, do uber-wealthy people use to avoid thetaxes?
It turns out that notonly can they afford tax attorneys, accountants, and estate planners, but there are also some tax benefitsthatrequire lots of money to even access. We’llshed light on some of those strategies available only to the extremely rich.
“As long as it’s done legitimately and there’s no fraud, I’m okay with it,” said Ed Smith, senior tax and estate planner at Janney Montgomery Scott.
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How much do rich people avoid in taxes?
According toU.S. Treasury estimates, the top 1% of wealthy people underpay their taxes by $163 billion annually.
How the super-rich avoid paying taxes
- Foundations
- Gifting
- Family offices
- Investments
- Moving residency
1. Foundations: Some begin with as little as $250,000, but a more feasible amount begins in the millions.
- Immediate income tax deduction of up to 30% of adjusted gross income (AGI) for your contribution but only distribute about 5% each year for charitable purposes. Because that 5% is calculated off the previous year’s assets, the first year requires no distribution.
- Avoid high capital gains tax and grow money tax efficiently.You can deduct the full fair-market value of the stock you contribute and not pay capital gains tax. If the foundation sells, it only pays 1.39% excise tax on the capital gains.
Example: Investing $250,000 in aprivate foundation eachyear for five years, earning 8% annually, yields about $1.43 million after excise taxes and minimum annual distributions of 5% to charitable activities. Contrast this with$1.38 million had the money been invested in a taxable account and paid capital gains taxes along the way.
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2. Gifting:
- Annual gift tax exclusion. In 2022, the limit was $16,000 and in 2023, it’s $17,000 per person. “If you have three kids and 10 grandkids, times two (me and spouse), that’s $34,000 per year to all 13 people that’s out of your estate and a tax-free gift,” said David Handler, Trusts and Estates Practice Group partner at Kirkland & Ellis LLP.
- Lifetime gift tax exclusion, which is separate from the annual gift. For 2023,it’s $12.92 million ($25.84 million for a married couple), and that amount generally rises each year based on inflation.
Note: The 2017 Tax Cuts and Jobs Act (TCJA) doubled the lifetime gift tax amount until December 31, 2025.Theamountreverts to the pre-TCJA amount of $5 million, adjusted forinflation, unless Congress extends it.
3. Family office: Typically, you need at least $100 million in assets to create a single-family office.
If properly structured, it can offer personalized services that include investment management, financial planning, estate and tax planning, philanthropic investing, concierge services, and more for family memberswith all the tax deductions of a business. The TCJA stopped individual taxpayers from deducting investment, accounting, tax and similar advisory fees until 2025, but a family office might be able to take them.
“Big wealthy families have the capability to do thisif they all agree and get along by making it a business and deducting what would be non-deductible,” said Smith.
Bonus: if your kids have skills that can be used in the family office or other business, you can hire them and pay them a hefty salary that’s expensed for the business and passed on to the kids, Smith said.
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4. Investments:
The average U.S. chief executive salary as of Jan. 26was$812,100, according to Salary.com. How can that be when we always hear that CEOs earn millions per year?
In contrast to thelower 99% who earn most of their income from wages and salaries, the top 1% earn most of theirincome from investments. From work, they may receive deferred compensation, stock or stock options, and other benefits that aren't taxable right away. Outside of work, they have more investments that might generateinterest, dividends, capital gains or rent if they own real estate.
Note: Real estate investments offer another benefit because they can be depreciated and deducted from federal income tax --another tactic used by wealthy people.
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5. Changingresidency:
“Jake Paul promoted it with a whole new section of the population,” saidtax attorney Adam Brewer.
Professional boxer and American social media personalities Pauland his brother Logan, who is also an actor and wrestler,moved to Puerto Rico partly to avoid high American taxes.
Puerto Rico is particularly attractive because U.S. citizens who become bona fide Puerto Rican residents –simply relocating doesn’t count -- cankeep their U.S. citizenship, avoid U.S. federal income tax on capital gains, including U.S.-source capital gains, and avoid paying any income tax on interest and dividends from Puerto Rican sources.
Normally, U.S. taxpayerswould have to give up their U.S. citizenship or green card to reap federal tax benefits.
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Not everyone’s ready to take that leap, though. ”A lot of people move to avoid state income tax,” Brewer said.
If you're abig earner, you could benefit from no income tax especially since the Tax Cuts and Jobs Act capped at $10,000 how much state and local taxes (SALT) you can deduct from your federal taxesthrough 2025. If Congress doesn’t act to keep this cap, SALT deductions will revert to unlimited.
States withoutincome tax:
- Alaska
- Florida
- Nevada
- New Hampshire
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
Can we get rich people to pay more taxes?
These are just a handful of ways ultra-wealthy people can legally avoid taxes. Although President Joe Biden proposed a national wealth tax when he took office, that's gone nowhere and now some states are trying to impose their own.
California, Connecticut, Hawaii, Illinois, Maryland, Minnesota, New York and Washington are introducing proposals to tax the rich. Each state has its own approach, but typical strategies include taxing assets andlowering the threshold for estate taxes.
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at mjlee@usatoday.comand subscribe to our freeDaily Money newsletterfor personal finance tips and business news every Monday through Friday morning.
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I'm an expert in taxation and financial planning with a deep understanding of the strategies employed by the ultra-wealthy to legally minimize their tax obligations. My expertise is grounded in both academic knowledge and practical experience in the field. Now, let's delve into the key concepts presented in the article:
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Tax Revenue Loss for the Top 1%:
- According to academic research cited by the Treasury Department, the top 1% annually underpays their taxes by an estimated $163 billion.
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Strategies Employed by the Ultra-Wealthy to Avoid Taxes:
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Foundations:
- Individuals can establish foundations with varying initial amounts, but a more practical starting point is in the millions.
- Immediate income tax deduction of up to 30% of adjusted gross income (AGI) for contributions, while only distributing about 5% annually for charitable purposes.
- Enables the avoidance of high capital gains tax and allows for tax-efficient growth.
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Gifting:
- Annual gift tax exclusion in 2023 is $17,000 per person, allowing for substantial tax-free gifts to family members.
- Lifetime gift tax exclusion is $12.92 million for 2023, rising annually based on inflation, providing additional opportunities for tax-free wealth transfer.
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Family Offices:
- Typically requires a minimum of $100 million in assets to establish a single-family office.
- Offers personalized services such as investment management, financial planning, and tax planning, with the potential for deducting certain fees.
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Investments:
- The top 1% earns a significant portion of their income from investments rather than wages or salaries.
- Real estate investments provide additional tax benefits, including depreciation and deductions from federal income tax.
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Changing Residency:
- Some ultra-wealthy individuals, like Jake Paul, have moved to locations like Puerto Rico to benefit from favorable tax conditions.
- Puerto Rican residents can retain U.S. citizenship, avoid U.S. federal income tax on capital gains, and enjoy tax exemptions on interest and dividends from Puerto Rican sources.
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Government Response and Potential Wealth Tax:
- President Joe Biden proposed a national wealth tax, though its progress has been limited.
- Some states, including California, Connecticut, Hawaii, Illinois, Maryland, Minnesota, New York, and Washington, are considering their own measures to tax the rich, involving strategies such as taxing assets and lowering estate tax thresholds.
In conclusion, the ultra-wealthy leverage a combination of legal financial instruments, such as foundations, gifting, family offices, strategic investments, and residency changes, to optimize their tax positions. These strategies, while within the bounds of the law, contribute to a substantial loss in tax revenue, prompting discussions about potential reforms and wealth taxation.
