According to the U.S. Department of the Treasury, the wealthiest Americans may avoid as much as USD 163 billion in income taxes yearly. While most Americans pay taxes through salaries and wages, the ultra-rich often use various strategies and loopholes to reduce tax liability and increase wealth. To bring you more information on the subject, the International Wealth team will explore some of the most common and effective ways that billionaires use to save on taxes.
A foundation is a charitable organization that supports various causes and activities. Foundations provide significant tax benefits for the donors who establish and fund them. For example, donors can deduct up to 30% of their adjusted gross income (AGI) for contributions to a foundation and avoid paying capital gains tax on the donated assets. Moreover, foundations only have to distribute about 5% of their assets each year for charitable purposes, which means they can grow their money tax-free and retain control over how it is spent. For illustrative purposes, billionaires with established foundations include Bill Gates, Warren Buffett, Mark Zuckerberg, and George Soros.
Property like real estate, art, or collectibles also offers tax advantages for the wealthy. One of the main benefits is depreciation, which is the decrease in value of an asset over time due to wear and tear or obsolescence. Depreciation allows property owners to deduct a portion of the asset cost from taxable income, reducing their tax bill. Another perk is the deferral of capital gains tax. The latter is the tax on the profit you make from selling an asset that increased in value. Property owners often defer paying capital gains tax by holding onto their assets until they die or exchanging them for similar assets in a like-kind exchange. This way, Jeff Bezos avoided paying capital gains tax on his USD 4 billion worth of Amazon stock by exchanging it for other assets.
Change of income type
Another way that billionaires save on taxes is by changing the type of income they receive. Generally, there are two types of income: ordinary and capital income. Regular income is from labor, e.g., salaries, wages, bonuses, or commissions. Capital income comes from investments (dividends, interest, capital gains, or rent). The difference between the two types is that ordinary income is taxed at progressive rates, which means the higher the income, the higher the tax rate. For capital income, on the other hand, preferential rates are used. These are lower than the ordinary income tax rates.
Hence, by converting their regular income into capital, billionaires lower their effective tax rate and save on taxes. For example, hedge fund managers can use the carried interest loophole, which allows them to treat their share of the profits from funds as capital gains rather than ordinary income. Similarly, corporate executives may receive stock options or restricted stock units, taxed as capital gains when exercised or vested rather than as regular income when granted.
Buying a sports team
Although it may seem like an expensive hobby, buying a sports team is also a smart tax move for billionaires. One of the reasons is that sports teams are considered intangible assets, which means they have no physical form and are difficult to value. This allows the owners to amortize, or write off, a large portion of the team’s purchase price over some time, usually 15 years. Financial tycoons often use the trick to reduce their taxable income and tax liability.
Another reason is that sports teams often generate losses, which can be used to offset other income and lower the tax bill. For you to see it more transparent, Steve Ballmer, the former CEO of Microsoft and the owner of the Los Angeles Clippers, reportedly paid USD 2 billion for the team in 2014 and has been able to deduct about USD 100 million per year from his taxable income.
Use of industries with substantial tax incentives
Some industries, such as oil and gas, renewable energy, or film production, offer substantial tax incentives for investors and producers. The above tax incentives are designed to encourage investment and development in these sectors, which are considered beneficial for the economy, environment, or society. These tax incentives include tax credits, deductions, exemptions, or deferrals. Do you know that Elon Musk, the founder and CEO of Tesla and SpaceX, has been able to take advantage of various tax credits for electric vehicles, solar panels, and rockets? This way, he has reduced tax liabilities and increased his net worth.
Deductions on side projects and high-class hobbies
Another way that billionaires save on taxes is by deducting the expenses related to their costly hobbies and side projects. The latter may range from collecting art, traveling the world, or launching rockets into space. The key is making these hobbies and projects look like legitimate business activities that qualify for tax deductions. Suffice it to say that Richard Branson, the founder of Virgin Group and a well-known adventurer, has been able to deduct the costs of his various attempts to circumnavigate the globe in a balloon, a boat, or a plane by claiming that they were part of his marketing and branding strategy.
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