If you’re one of the 1% of Americans who control over 40% of the country’s wealth, life is full of choices. Among them — how best to keep all that money away from the government? The U.S. economic system offers no shortage of loopholes allowing the ultra-rich to shortchange Uncle Sam.
Tax rates for those making >$1 million level out at 24%, then declines for those making >$1.5 million. Those making $10 million a year pay an average income tax rate of 19%. $70-$100 billion is the estimated tax revenue lost each year due to loopholes. So how exactly do the super rich hide that much money from the government every year?
In August, Mohnish Pabrai took part in Brown University's Value Investing Speaker Series, answering a series of questions from students. Q3 2021 hedge fund letters, conferences and more One of the topics he covered was the issue of finding cheap equities, a process the value investor has plenty of experience with. Cheap Stocks In the Read More
1. Put It in the Freezer
Trust Freezing: A way to transfer valuable assets to others (such as your children) while avoiding the federal estate tax.
“Freeze” the value of assets many years before you plan to pass them on to exclude all asset appreciation from the estate, and any taxes.
Popular method: Trade common for preferred stock.
Problem: If you sell your common stock you might owe a large amount of capital gains tax.
Solution: Trade your common stock for preferred stock, then put some of the preferred stock in a trust and live off the dividends.
2. Send It Overseas
Tax havens: Registering your business or putting your money in an account in another country with lower taxes.
~$21 trillion is being hidden in offshore tax havens.
David Bowie, U2 and the Rolling Stones have all benefited from tax havens at one time or another.
Popular cash hideout: The Cayman Islands, home to >85,000 companies — making it home to more registered organizations than people.
3. Stock It Up in Options
By taking part of your compensation in stock options you can control when and if you pay taxes, since most options are only taxed when they are exercised.
Execs who have opted for options: Howard Schultz (Starbucks), Fred Smith (FedEx), William Weldon (Johnson & Johnson) and many others.
4. Play Shell Games with It
Shell company: A type of company that only exists on paper, allowing you to funnel money through it and avoid paying taxes.
Has a legal existence but typically provides few or no actual products or services.
Often used for buying and selling to avoid reporting international operations conducted, and avoid taxes on the profits.
Shady business: Mitt Romney caught some flak for allegedly using a shell company in Bermuda to avoid taxes.
5. Swap It Out
Equity swap: An agreement that allows 2 parties to exchange the gain and loss of assets without actually transferring ownership.
The swap avoids transaction costs, and typically, local taxes on dividends.
6. Play Dodgeball with It
Capital gains tax: A tax on the profits from a sale of non-inventory assets originally purchased for a lesser amount, such as stocks, bonds, property or precious metals.
Popular loophole: Purchasing stock options, which sets the share price at a fixed rate, then borrowing money from an investment bank using the shares as collateral.
The borrower then repays the loan either with money made with the money borrowed or by handing over the shares, avoiding the capital gains tax.
7. Go Corporate with It
Problem: being in a higher income tax bracket has less tax advantages than being a corporation.
Solution: You can incorporate your own personal brand, which allows you to: 1. Channel wages through a nominal “corporation”; 2. Pay yourself an interest-free wage; 3. Claim expenses; 4. Reduce your income taxes.
Mitt Romney claimed the management fee of his corporation as a capital gain rather than income, reducing his tax rate significantly.
8. Kick It Down the Road
You can put part of your payday in a deferred-compensation plan, instead of taking it all at once.
This allows your earnings to continue growing tax-deferred for +10 years.
79% of CEOs at Fortune 100 companies were offered deferred compensation plans.
9. Give It Away
Gift-giving and charitable donations are a real win-win: Avoid taxes and look and feel good doing it!
Gifts to anyone of up to $13,000 are tax-excluded, with an unlimited exclusion for gifts given to a spouse.
Allows you to circulate cash within the family as “gifts” while writing it off.
Popular donation tactic: Deduct the fair market value of a donated item from your tax liability.
Example: 1. Buy a sculpture for $1,000; 2. Have it appraised at $10,000 some years later; 3. Donate it and deduct the $10,000 from that year’s taxable income. Score!
10. Make It Luxurious
Owning a yacht or multiple homes aren’t just status symbols — they offer tax benefits as well!
Popular earner: Claim your “second home”
Spend at least 2 weeks of the year on your yacht, outfit it like a home, and categorize it as a second home for tax purposes.
If the home’s value appreciates over time, the profits from selling it can be considered capital gains and taxed at a lower rate than salary or other investment income.
A second home can be rented for up to 2 weeks a year without requiring the owner to claim the rent as income!