When tax time comes around, middle-class Americans are trying to maximize their refunds, minimize their taxes, and claim every deduction and credit they can. They want to rush through this annual chore so they can get by until it's time to do it all again next year.
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But for the wealthy, tax planning joins income and investment as the top three tools for preserving and building wealth. From charitable giving to trusts used to pass on assets, comprehensive tax planning has become a central pillar of wealth preservation for America's wealthiest families.
Here's how tax season is different for America's millionaires and billionaires.
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Tax planning has always been an important issue for the wealthy.
For the average middle-class earner, W2s, 1099s, and bank and brokerage interest papers start arriving in January, and then you collect and organize them until you have until April 15 to file your tax return.
But for the wealthy, tax planning is a part of everyday life and a top priority in most financial decisions, 365 days a year.
“HNWIs manage their finances with a clear focus on tax planning, which is very different from the middle-class approach, which only considers the tax impact when they have to file their annual tax return,” said Johan Garcia, a CPA with a Master's in Taxation and more than 10 years of experience in tax advisory, tax compliance and business advisory. “HNWIs estimate their annual tax liability on a quarterly basis, forecasting taxable income from various sources and adjusting their forecasts based on actual results as the year progresses.”
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They never put off paying taxes
Garcia said considering tax implications year-round gives wealthy individuals an accurate and evolving understanding of their tax liability, which helps them make informed decisions regarding taxable activities.
“For example, selling investment assets, making charitable donations or adjusting your investment strategy,” says Garcia, who previously served as chief tax strategist for a publicly traded Fortune 500 company and is now owner of After Tax Cash and principal at JG CPA & Advisory. “The example I covered today is a high-net-worth taxpayer who frequently travels to New York for business purposes. He or she needs to track the number of days spent in New York, because after X number of days, the taxpayer is considered a part-time resident of the state and may be subject to New York state income tax on their entire taxable income.”
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Middle-class Americans typically file their own taxes using software like TurboTax or get help from a local CPA or a national accountant chain like Jackson Hewitt.
“Most middle-class people choose to file their own taxes, and unless they're a tax professional, they're not going to get the benefits,” said Miles Brooks, CPA and director of tax strategy at Coinledger.
Meanwhile, wealthy individuals may employ a team of professionals or work exclusively in a family office.
“In my experience, the wealthy are very tax-conscious,” Brooks says. “Because they can afford financial and tax professionals, they have the legal structures and financial tools to maximize deductions and minimize their tax burden.”
Their team includes wealth managers, tax accountants, accountants, philanthropic professionals and investment advisors, all of whom are involved in the financial lives of their wealthy clients not just right before tax season but throughout the year.
Invest strategically as part of your tax planning
In 2019, CNBC investigated how the ultra-rich pay low taxes, and one strategy was to invest more in stocks and then manage and diversify their gains, since long-term capital gains taxes are generally lower than income tax rates.
This is just one tactic: the wealthy make almost all of their investments with the IRS in mind.
“The wealthy invest strategically, and that has tax implications that most middle-class people don't consider when they decide to invest,” Brooks said. “Most wealthy people earn income from investments, and most of them choose capital gains because they are taxed at lower rates than ordinary income, and they also take advantage of capital gains deferrals when they hold their investments for the long term.”
Meanwhile, most middle-class Americans contribute to retirement and brokerage accounts based solely on investment strategies and 401(k) plans, and calculate their tax liability when they receive their 1099-B or fill out a Schedule D during tax season.
The wealthy pay close attention to timing
For the middle class, the IRS will determine the timing of tax-related filings. The IRS will start accepting tax returns in late January (January 29th this year) and set the filing deadline around April 15th.
But the wealthy are one step ahead of the Treasury: They start buying, selling and trading assets to their advantage well before tax season.
“Timing is everything, even when it comes to taxes,” Brooks says. “The wealthy have flexibility in the timing of their income. They delay capital gains and bonuses for a few years to reduce their tax burden, and they also delay deductible expenses.”
But you don't have to be rich to play this game: even middle-class investors can engage in tax loss recapture, deliberately selling investments at a loss at the end of the year to offset capital gains.
Treating deductions and credits like income
Most Americans figure out what deductions they are entitled to and can claim by entering their information into their preferred tax software.
Wealthy people are more proactive.
“Most wealthy people take deductions and credits very seriously,” Brooks says. “They take advantage of provisions like real estate depreciation, charitable contributions, and business expenses to reduce their taxable income.”
Their team of experts develop strategies throughout the year to maximize tax deductions and deductions, and Brooks says most also incorporate estate planning for asset gifts and the establishment of trusts to pass on wealth and further reduce the tax impact.
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This article originally appeared on GOBankingRates.com: 6 Ways the Wealthy Pay Taxes Differently than the Middle Class
