How Rich People Legally Avoid Taxes, and You Can, Too!
Taxes are the single largest expense most people will pay in their lifetime, not homes, not cars, not student loans, Taxes. And I find it so surprising that people are ready to spend so much time scouting on the internet to find a 10-dollar discount but don't bother to take the time to educate themselves on something that is so fundamentally important to life. So, in this blog, I will explain how taxes work and talk about the most common ways to legally reduce your tax burden. This is going to save you 1000s of dollars every year. I know tax laws are highly country-specific, but certain aspects are common and applicable no matter where you are. So, let's get started.
Most people believe that as their earnings increase, so do their taxes. This is not completely true. Let's take the example of the wealthiest man on the planet, and the founder of Amazon, Jeff Bezos. Can you guess how much he pays in taxes? According to data obtained by ProPublica, an independent, nonprofit organization, between 2014 and 2018, Bezos paid only a true tax rate of 0.98%. Now true tax rate is the tax amount paid annually compared to the estimated growth in wealth during that time.
Here's another example: Warren Buffett, widely regarded as the greatest investor the world has ever seen, has a net worth of over $100 billion, but he pays just 0.1% in taxes. That’s right. 0.1%. Buffet himself disclosed in a press conference that he was paying less in taxes than his secretary. I could easily give you a thousand examples. And then…there’s you and me. Probably working on a day job, earning a monthly salary.
At the end of each year, our employer mails us the tax statement, we take a look at it and wonder "Why is 40% of my income lost to taxes? This world is not fair". It's true, the world is not fair. The rich have their circle of influence, access to tax havens, and an army of tax attorneys. But you and me, we only have ourselves. We've got to understand the tax system and find every loophole or opportunity to get back what's rightfully ours.
As Ben Franklin said, in this world, nothing is certain except death and taxes. However, there was a time when taxes were not the norm. Taxes were only imposed on people in times of war, but then the governments fell in love with the idea and made it permanent. But taxes as such are not a bad thing. Governments need money to work and taxes are an important part of running a civilized society. The problem occurs when they are too high and are unfairly used against people.
Most countries, use a progressive tax system with marginal tax brackets also called tax slabs to tax the income. Tax slabs are like buckets, with each bucket having a different tax rate and limit. The higher the income, the higher the slab. However, this doesn't mean you pay a single rate for your entire salary.
For example, suppose these are the tax slabs in your country. Zero percent for an income below $10000, 10% for an income up to $50,000 20% for an income up to $100,000, and 30% for any income above it. So if if your taxable income is $150,000, you normally fall into the 30% tax bracket. This is called the marginal tax bracket. It's called marginal because only a portion of income is taxable at that rate. You only pay the tax for the money belonging to each slab according to the corresponding tax rate. And this more or less applies to most of us irrespective of which country we are in or what kind of job we do.
Except for the rich business people out there. Because they don't earn much in the form of an income. Tesla pays Musk around $37,000 annually, and Larry Page, founder of Google, earns a salary of just $1 a year. If a rich man owns a company, he will not register himself as an employee of that company to avoid paying an income tax. Rich only pay capital gain tax and corporate tax which are far lower than the income tax rates. Every government in the world knows it is not fair, but still, each one of them allows this. Why?
Because the government doesn't need you and me. They need the rich. And if the Governments don't make the rich happy they will leave. When you have hundreds of millions of dollars, virtually every country is open to you. What's the problem if the rich leave? The rich have the platforms, companies, and corporations that provide the middle class with income. If the government hurts the rich, the economy will feel the impact. So what can a common person like me and you do? You will know if you are smart enough to read this blog until the end.
Tax deductions and credits
The best way to save taxes is to reduce your taxable income. And there are two ways to do that. Either by making use of deductions or using tax credits. They both work differently and I will give you an example to understand it better. Let's say you make $100,000 a year and you are taxed at 25% which brings your yearly taxes to $25,000. If you receive a $10,000 tax deduction, your taxable income now becomes $90,000 and your tax bill is reduced to $22,500. But now let's say, instead of receiving a tax deduction, you receive a $10,000 tax credit. Now that tax credit is applied directly to the $25,000 in taxes you owe. So your final tax bill comes out to $15,000, and all in all, you save $10,000. So credits are usually better than deductions because they can reduce the tax you owe. Governments around the world offer various tax credits.
For example, in the US a tax credit is available for those who install solar panels for home use. There are also tax credits that can offset the costs of child and dependent care. Go to your government tax website search for available tax credits and make the most out of the ones that apply to you.
Deductions are typically contributions to retirement and healthcare. In the US this includes options such as the traditional and employer-sponsored IRAs and Health savings accounts (HSAs). You can contribute up to $7,000 into a traditional IRA, $23,000 into a traditional 401(k), and $4,150 into an HSA tax-free. This equates to about $35,000 in tax deductions simply by saving for the future. If you're married, you can get twice as much. In my home country India, we are allowed to invest up to Rs 150,000 a year into a pension fund with no tax on interest during the period and no tax on your gains on exit. Such deductions are gifts from every government to the middle class, so use them to the fullest.
Now my favorite way to reduce taxes is by having expenses. In every aspect of life, having more expenses than income is bad except for one. Filing your taxes. This is what the rich do most to reduce their tax burden. The rich run businesses, and what do businesses have? Expenses. If Bezos made $10 million in profits this year and wants to avoid $2 million in taxes, what does he do? He buys 250 Amazon delivery trucks worth $10 million for his business that can be deducted from his profits, and now, in the eyes of the tax office, he didn’t make $10 million, he made $0.
You don’t need to own a big company to benefit from tax deductions. But you need to understand that the tax code is tailored in favor of people who can earn money outside of a full-time traditional job. If you have a side hustle or even a freelance gig, you too can write off your expenses against your income. I did this with my YouTube channel. Last year, I bought some camera gear and a laptop which I claimed as business expenses, and got a considerable amount back from the tax office.
Capital Gains instead of Income
Investing can be an important tool in growing wealth, but it can also help to save taxes. For example, in the US, if we lend money to the government in the form of municipal bonds, the income we earn will be exempt from federal, state, and local taxes. Every government provides such tax-free investments, so it's worth having a look and considering investing in them if we want to reduce our taxes.
But even if we don't invest directly in tax-saving government securities, every other investment we make saves us taxes. Because profits from our investments are not taxed at the normal income tax rates we saw earlier. I will explain.
We can all agree that, when it comes to investing, the goal is generally to sell our investments at a higher price than what we purchased them for. However, when we make a profit from selling something we own, like an investment or piece of artwork, we incur capital gains. This is taxed at a rate based on how long we held on to the asset before selling. If we sell a stock after holding it for less than a year, we'll face a short-term capital gains tax. However, if we sell a stock after holding it for more than a year, we'll pay a lower long-term capital gains tax. But both these taxes are normally far far lower than the high income tax we've been paying for our salary. So the key takeaway is to invest in assets, hold on to them for the long term, and make most of your income from capital gains.
But then that's not it. There are also other strategies available to further reduce the taxes from capital gain. We can use our investment losses to offset the taxes we would pay on other investment gains, thereby lowering our taxable income. This is called tax-loss harvesting.
And then there is the "buy, borrow, die" strategy. This technique is often used by the rich to pay zero taxes on capital gains. Under U.S. tax law, we don't have to pay any tax on investment gains until we sell, no matter how much they've gone up. This is known as unrealized capital gains. And the rich, they never sell. Why should they sell and pay capital gain tax, when they can easily take out loans with their investment assets as collateral? The best part is that interest rates for these loans are lower than what we can get with a traditional loan. The core idea is to purchase investments that appreciate, borrow money against those assets, and then pass on those assets to heirs tax-free.
Charity
And finally for those with a kind heart, now could be a good time to consider giving more. If philanthropy is important to you, and if you regularly donate to charities and declare your deductions on your income tax returns you will qualify for a tax refund. Just keep in mind that to claim a deduction, you must have donated to a charity recognized by your tax office.
I know taxes may be a bit daunting. But if you put some effort into understanding and educating yourself, that knowledge can save you a lot of money every year. I hope you got some value from this blog. If you like this blog, give it a share so that the message can reach more people and help them also to save taxes. And if you want to read more related blogs to save money and build wealth, then do share with your network.
Disclaimer: The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. It is important to do your own analysis before making any investment.
