The U.S. Tax Code is ridiculously complex and full of potential loopholes, and there are at least a few stories in the media every year about rich people using foundations, trusts and other legal loopholes to end up paying little to no taxes. Well, it turns out there is at least a kernel of truth to these stories. Although the percentages are small, there were almost 14,000 tax filers in 2012 among the 5.3 million filers with adjusted gross incomes above $200,000 who paid no income taxes in the U.S. or anywhere else.
Of note, the main reason for high income individuals having no income tax liability in most cases is that all or nearly all of their income was tax exempt interest income.
IRS looks at both U.S. and worldwide income tax liability
To identify the high income filers who pay no income tax at all, the IRS examined both “U.S. income tax” is total Federal income tax liability, which includes the AMT, less all credits against income tax, and “worldwide income tax.” Worldwide income tax adds back the allowable foreign tax credit and foreign taxes paid on excluded foreign-earned income to U.S. income tax. According to the IRS, the sum of these two items represents a “reasonable proxy” for for foreign taxes actually paid by a filer.
The total number of income returns over $200,000 increased 11.6% to more than 5.3 million returns in 2012. However, it turns out that 13,450 of these high income returns actually had no worldwide income tax liability at all. The IRS report notes this represents a 10.3% decline in the number of returns with no worldwide income tax liability from the year before, and the third consecutive down year after hitting an all-time high of 19,551 returns in 2009.
As noted above, tax-exempt interest was the primary reason for nontaxability on 54.2% of these no tax paid returns.
Keep in mind that the $200,000 AGI threshold threshold was fixed in 1976 and not adjusted for inflation. If you look at the situation in 2012 dollars, an income of $807,009 is required to equal the same purchasing powers as having $200,000 of income in 1976. Running the numbers with an inflation-adjusted threshold, there are 545,246 high income returns, a 23.8% boost from 2011.
However, despite this notable increase, the number of high income returns with no worldwide income tax on an inflation-adjusted threshold dropped by 38.1% down to just 547 returns. Of note, this was the fewest high income returns with no worldwide income tax since 2007 (314 returns).