Medora LeeUSA TODAY
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Armed with $80 billion in funding, the IRS is hoping to boost compliance this tax season to capture some of the more than $160 billion in tax revenue the Treasury says it loses every year because the top 1% finds ways to avoid paying “their fair share."
The Inflation Reduction Act, signed in 2022, provided the IRS with fresh funding to help it beef up its staff and modernize its computer systems to get rich people pay more. Last September, the IRS posted 3,700 jobs "that generally focus on audits" and "higher-income and complex tax areas like partnerships, not average taxpayers making less than $400,000."
What tactics, though, are uber-wealthy people using to avoid thetaxes?
It turns out that notonly can they afford tax attorneys, accountantsand 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 OK 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
- Property
- 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. Property: If you own property, you can benefit from depreciation, which is how much the value of an asset decreases over time due to use, wear and tear or obsolescence. Depreciation can be deducted from your taxable income every year and is a tactic former President Donald Trump and his son-in-law Jared Kushner famously employed year after year to avoid taxes.
The IRS allows several types of assets that can be depreciated if used for your business such as personal property like cars, trucks, equipment, furniture or real property that includes buildings or anything else built on or attached to land. Land, though, is never depreciated. In 2023, the maximum expense deduction is $1,160,000 for most property. Residential rental property can be depreciated over 27.5 years and commercial property over 39 years.
However, there are different ways to calculate depreciation, some that can be more lucrative in the short-term than others. Here are the basics:
Straight line depreciation: the most commonly used method is calculated by simply dividing the cost of an asset, less its salvage value, by the useful life of the asset. For example, if I purchased a $220,000 building to rent and the building was valued at $200,000 and the land at $20,000. I would then be able to depreciate $200,000 over 27.5 years or $7,272 annually.
Cost Segregation Study: when tax experts and engineers study the various components of your building – such as its wiring, plumbing, light fixtures, flooring and exterior improvements – to determine if you can accelerate the depreciation of some of them. For example, HVAC systems, parking lots and carpeting may depreciate faster, say 5, 10, or 15 years or may even be allowed to be fully expensed in the first year. That means big deductions in the first few years and then declining as years pass, a good thing especially if you're not likely to hold a property for 27.5 or 39 years. You can reap most of the tax benefits upfront before selling.
Note: You can't take a depreciation deduction on your personal home, but the tax code includes an exemption for limited renting. It says if a property is rented out for 14 days or less in a calendar year, the income is tax free. "It started with the Masters Tournaments with golf course homes," said Mark Steber, chief tax officer at preparer Jackson Hewitt. Resident of Augusta are famous for renting out their properties for the tournament and leaving town for a spring vacation. Some large, nearby luxury homes go for as much as $70,000 per week
"They rent for 14 days and don’t even have to report it to the IRS," said Steber, who notes that this practice has broadened out to luxury ski homes to ocean front properties. Of course, you have to own and live in one of these homes first to do this.
3. Gifting:
- Annual gift tax exclusion.In 2022, the limit was $16,000;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.This 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 doubled the lifetime gift tax amount until December 31, 2025.Theamountwill revert to the pre- amount of $5 million, adjusted forinflation, unless Congress extends the act.
4. 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 andconcierge services for family memberswith all the tax deductions of a business. The 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 nondeductible,” 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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5. 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 the99% 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,if they own real estate, rent.
Real estate investments, as seen above under property, offer another benefit because they can be depreciated and deducted from federal income tax –another tactic used by wealthy people.
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6. Changingresidency:
“Jake Paul promoted it with a whole new section of the population,” saidtax attorney Adam Brewer.
Brothers and social media personalitiesJake and Logan Paul moved to Puerto Rico in part to avoid high U.S. 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 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 you can deduct from your federal taxesthrough 2025. If Congress doesn’t act to keep this cap, state and local taxdeductions 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.
