6 Completely Legal Strategies The Super Wealthy Use to Lower Their Tax Bill

Earlier this year, ProPublica revealed in an illuminating report that many of America’s wealthiest billionaires – Jeff Bezos, Elon Musk, Warren Buffett, and more – have repeatedly paid no income taxes to the IRS year after year. 

Whatever your personal feelings are on whether these men should pay income tax or not, the fact remains that they have avoided paying income tax perfectly legally. And they’ve used a variety of strategies to do so. 

While these strategies may not be available to the average working joe, they may be useful to other savvy investors who are looking for ways to legally keep more of what they make – or at least give their money to individuals or entities other than the US government. We’re sharing some of those strategies with you today.

1. Taking Little to No Annual Income

The first strategy most billionaires use to lower their taxes is to earn very little in annual wages, if any at all. Perhaps most famously, Steve Jobs chose to earn only a single dollar in wages in the 1990s when he returned as the CEO of Apple. Jeff Bezos reportedly earns a modest $80,000 a year from Amazon, and he doesn’t pay himself raises as the company earns more profits. 

But these billionaires aren’t taking low wages as an act of self-sacrifice or inspiration to their employees. Earning low wages is a tax strategy. Compared to other types of income such as dividends and asset sales, wages are taxed at much higher rates. 

Instead, billionaires measure their wealth by holding on to the highly-valuable shares in the companies they own and they fund their lifestyles in other ways (see more below).

Additionally, business moguls like Warren Buffett do not pay dividends to shareholders, which minimizes taxable income. Instead of paying (and earning) dividends from company stock, billionaire business owners reinvest earnings into their companies to grow the value of the shares. 

2. Borrowing Money to Fund Their Lifestyles

Because much of billionaires’ wealth is held in unrealized gains from the shares they own, you may be wondering how they fund their expensive lifestyles. The answer lies in borrowing money. By taking out loans backed by the value of their company shares, billionaires not only fund their lifestyle, but they can also deduct their interest payments from earned income they do report on their tax returns.

This strategy offers the double incentive of mitigating the need to earn taxable income, as well as reducing any taxable income they do earn. In today’s low-interest-rate environment, it’s a no-brainer to see why billionaires come out on top by paying single-digit interest rates on borrowed money rather than a 37% income tax rate or 20% capital gains tax. Meanwhile, their investments continue to appreciate.

3. Offsetting Gains With Losses

Another strategy the ultra-wealthy use to minimize their tax liability is to offset their gains with losses. For example, a high-earning executive may earn stock options as part of her compensation package. When it’s time to sell those stocks at a profit, she may sell other investments that are performing poorly to offset those gains and thus avoid the capital gains tax.

Other investors may offset their gains by choosing to realize gains only in years their taxable income will be lower. Using a strategy known as bunching, wealthy earners can bunch their tax deductions in certain years to optimize the increased standard deduction that came as a result of the Tax Cuts and Jobs Act. Bunching allows investors to realize gains in more optimal years when their taxable income has been reduced by itemized deductions.

4. Backdoor Roth Conversions

A backdoor Roth conversion occurs when an individual contributes money to a non-Roth investment account and then converts it to a Roth account. The main advantage of this strategy is that investors pay income taxes upfront on their converted funds. All withdrawals from the Roth in the future, including investment gains, are tax-free. There are also no required minimum distributions on a Roth IRA since the government has already received its tax payment.

A backdoor Roth IRA conversion is not subject to the contribution limits a regular Roth IRA (or any IRA) is subject to. Additionally, anyone can take advantage of a backdoor Roth IRA, because investors who earn over a certain income threshold are not prohibited from converting investments to a backdoor Roth account.

5. Strategic Estate Planning Techniques

Estate taxes aim to recoup a portion of an individual’s massive fortune by assessing a 40% tax on property valued over $11.7 million ($23.4 million for married couples) at the time of death. The purpose of the estate tax is essentially to prevent a small number of families from controlling the majority of the nation’s wealth across generations.

However, there are ways to shield assets from the estate tax. Some philanthropically-minded individuals create foundations for which a majority of their estate will pass into upon their death. Others place large sums of money into specific types of trusts that are passed to their heirs without being subject to estate taxes. 

6. Charitable Giving

Finally, charitable giving remains one of the ultra-wealthy class’s favorite ways to reduce their taxable income. Warren Buffett has stated that he plans to donate 99.5% of his estate to charity when he passes away, believing “the money will be of more use to society if disbursed philanthropically than if it is used to slightly reduce an ever-increasing US debt.”

Charitable giving only reduces taxes when individuals itemize their tax bill, and itemizing only makes sense when the total anticipated deductions add up to more than the standard deduction. Because the standard deduction nearly doubled as a result of the Tax Cuts and Jobs Act, many individuals have had to be more strategic about their itemized deductions, thus the bunching strategy described above.

How Other Wealthy Investors Can Use These Strategies

Working with a qualified financial advisor and estate planner is the best way to optimize these strategies legally. Qualified financial professionals can educate you about strategies that may work well for your unique situation and provide guidance on different actions you can take year to year as your circumstances change. 

Although many of these strategies have recently been under close scrutiny from Congress – particularly Congressional Democrats – none have been included in any new tax reform legislation thus far. With that being said, wealthy investors may want to take advantage of many of these strategies soon rather than later.

How Chicago Trust Administration Services Can Help

At Chicago Trust Administration Services, we help savvy investors increase their return potential by investing in alternative assets through a self-directed IRA. With a self-directed IRA, you still receive the tax benefits of traditional and Roth retirement accounts, but with much more freedom and flexibility to invest in a wide range of assets. 

Our role is to administer your self-directed IRA and ensure your investments are made with IRS compliance in mind. To see how we can help, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.

___________________________________________________________________________

*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.