In America, it's almost always better to have more money than less, and it's especially nice to get rich come tax time.
“Wealthy people often have tax-saving opportunities that are hard to come by for the middle class,” says former Wells Fargo financial advisor, general counsel for financial and tax strategies, and finance director for LLC attorneys. Jonathan Feniak says.
It's not just the size of bank accounts that separates the wealthy from the masses. The IRS has much more power over one group than the other.
When money makes money, the IRS costs less.
In general, the wealthy earn most of their income from capital gains, and the middle class earns most of their income from exchanging labor for money, that is, working for a living.
According to a 2023 report from the Brookings Institution, “The most recent data show that investments and businesses accounted for 82% of income for the top 0.01% and 88% for the top 0.001%, compared to just 7% for the bottom 80% of households.”
This is an important distinction because the IRS takes a larger percentage of the money you earn from your job than the money you earn from investments.
“Because they have large capital gains, they can benefit from long-term capital gains tax relief, which is generally lower than income tax rates,” Feniak said.
Brookings sums it up this way: “Wages face heavier taxation than capital income, even though wages are distributed primarily to low- and middle-income households and capital income is distributed primarily to high-income households.As a result, wages face heavier taxation than capital income. The highest income households often pay a lower share of their income in taxes than middle-class households.
When people make money, the IRS collects more taxes
In a 2023 research report entitled “The Limits of Taxing the Wealthy,” the Manhattan Institute stated: 85% of capital gains are reported by the top 5%. ”
“On the other hand, the middle class earns primarily through wages, which are subject to higher income tax rates,” Feniak said.
The IRS taxes long-term capital gains in stages, up to a maximum of 20%. That means even the wealthiest households can pay only a fifth of a dollar in capital gains.
But if the investment income that wealthy people rely on is taxed as ordinary income, or if they earned most of their money working like the middle class, they receive 37% of their income as members instead of 20%. will have to be forfeited to the IRS. of the highest tax bracket. In effect, wealthy people can receive a tax cut of nearly 50% by not working most of their income.
A mountain of unrealized gains: the wealthy can buy, borrow, and die without ever meeting the tax office
According to Americans for Tax Fairness, “Most Americans live primarily on income earned from work, income that is taxed annually throughout the year, but the wealthiest households may never be taxed.” They live a luxurious life with no capital gains.”
Here's how it works:
Wages and short-term capital gains are taxed as ordinary income at higher rates. Long-term capital gains are taxed at a lower rate. However, investments are not taxed at all until they are sold, and any profits earned until they are sold are called unrealized gains.
Who needs to sell an investment once when you can borrow it forever?
According to Federal Reserve data, America's billionaires and centillionaires (those worth at least $100 million) hold a total of $8.5 trillion in untaxed income holding unrealized gains.
But they can't access that wealth until they sell their holdings, at which point they'll be taxed, right? Think like a middle class wage earner.
According to Forbes, the ultra-wealthy use a “buy, borrow, die” strategy to cash out huge unrealized gains and pay taxes to live lavish lifestyles that they could afford without doing either. It is said that there is
Instead, they finance their holdings with flexible, low-cost, easily approved loans called securities-backed lines of credit (SBLOCs). When they die, their heirs can sell enough stock to cover the loan and repeat the process without paying capital gains taxes, thus receiving a step up in cost basis.
Middle-class investors, on the other hand, have most of their assets tied up in retirement accounts, paying taxes either before contributions (Roth accounts) or when they receive distributions, such as in 401(k)s and IRAs.
Death is certain.Taxes are not that much
Benjamin Franklin famously said, “Nothing is certain but death and taxes.” But the rich are masters at exploiting the former to avoid the latter.
“High-net-worth individuals typically have access to sophisticated tax advisors who can help them take advantage of tax deferral strategies, such as the use of trusts and complex estate planning,” Feniak said.
For example, a ProPublica report shows how some of America's wealthiest billionaires use Grantor Retained Annuity Trusts (GRATs) to avoid taxes on intergenerational wealth transfers. I revealed what I was doing.
“A typical GRAT involves placing assets, such as stocks, in a trust that will ultimately benefit an individual's heirs. However, any investment gains in excess of that amount flow to the heirs without gift or estate taxes.Thus, if a person leaves $100 million worth of stock in a GRAT, the value of the stock is $130,000. If the amount increases to $30,000, his heirs will receive approximately $30 million tax-free.”
The middle class, on the other hand, pays taxes throughout their lives and often even after they die.
According to PlannedGiving, nearly 7 in 10 Americans don't even have a basic will, much less a trust or complex to protect heirs and ensure their assets are passed on as they wish. There are no proper estate planning tools in place, and of course there are no means in place to minimize the number of heirs. tax.
“They often have even more limited access to tax reduction strategies because of the cost and complexity of tax preparation services,” Feniak says.
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