For many average citizens, income tax season brings a degree of financial scrutiny; however, for the ultra-wealthy, this period holds far less significance. This is primarily because their vast fortunes are not predominantly derived from conventional income sources. Instead, billionaires strategically minimize their declared income, opting to sustain their opulent lifestyles by leveraging appreciating assets like stocks, real estate, and thriving businesses, which are subject to different tax treatments.
A recent academic investigation by professors at the University of California, Berkeley, brought to light a significant disparity in tax contributions. The research indicated that America's most affluent individuals bear an overall tax rate that is approximately 20% lower than that of an average American household. Brian Galle, a law professor at Berkeley, emphasized the stark contrast, highlighting that a typical household, often with zero net worth due to combined assets and debts, faces a higher tax burden than billionaires. This situation, he noted, underscores a tax system that is neither equitable nor progressive.
The working populace primarily depends on hourly wages or fixed salaries, which are subjected to escalating tax rates, ranging from 10% to 37%, based on income brackets. Consequently, these individuals contribute a substantial portion of their earnings to federal income taxes, alongside payroll, state, and local taxes. For instance, a hypothetical married couple filing jointly, earning $110,000 annually, after a standard deduction, would incur an effective tax rate of around 8.13% on their taxable income.
Conversely, billionaires often report minimal income because their wealth accumulation largely stems from investments rather than a conventional paycheck. Capital gains and other forms of wealth appreciation are typically taxed at rates lower than those applied to earned income. The Berkeley study concluded that the 400 wealthiest households in the United States effectively pay a tax rate of 24%, while the majority of the population faces a 30% rate.
Many of the ultra-rich are compensated with equity rather than cash. By maintaining modest salaries, they reduce their income tax obligations. Their holdings in vast enterprises or substantial stock portfolios, which may not yield high dividends but appreciate exponentially over time, are only taxed upon sale—a principle known as 'realization.' Professor Galle, in his report "How to Tax the Ultrarich," explains that this allows the wealthy to choose when, if ever, to pay taxes on their investment gains.
Consider a scenario where a billionaire's net worth surges by billions within a year due to stock market performance, business expansion, or real estate value increases. If these assets remain unsold, the tax liability could be nil. Should a portion be liquidated, it would likely be subjected to lower capital gains taxes, circumventing the higher income tax rates. This allows some tycoons to report nominal taxable incomes, sometimes even less than those of the IRS agents who audit them, as exemplified by figures like Jeff Bezos, whose reported taxable income has been notably low despite immense wealth growth.
A particularly effective strategy employed by the extremely wealthy to sidestep high tax bills is the 'buy, borrow, die' approach. This involves acquiring valuable assets, leveraging them as collateral for loans to fund their lifestyles, and eventually passing these assets to heirs. Upon inheritance, a 'step-up in cost basis' resets the asset's value, effectively erasing a lifetime of appreciation and nullifying capital gains taxes. Borrowing against equities offers favorable interest rates, and loan proceeds are non-taxable, with interest payments potentially being tax-deductible, all while the underlying assets continue to grow.
The tax-avoidance tactics utilized by the ultra-rich are largely unattainable for average American households. Nevertheless, individuals with real estate or other income-generating assets can adopt certain strategies to alleviate their own tax burdens. These include maximizing contributions to retirement accounts, donating appreciated stock to charitable organizations for tax deductions, and deducting expenses such as depreciation, insurance, and interest on real estate investments. Furthermore, structuring property and businesses through 'pass-through' entities like LLCs or trusts can defer taxes and shift income to lower tax brackets. Harvesting tax losses to offset gains is another method to minimize tax liabilities.