Billionaires are usually defined by their extreme wealth, but most of their fortunes are not derived from their salaries. Most of their wealth comes from the ability to navigate complex economic structures that allow them to keep taxes low while continuing to amass significant income from their investments and businesses.
While the majority of middle to upper-class Americans pay a significant amount of their income in taxes due to the kind of income they earn (W2 active income), the upper class employ a variety of methods to protect a greater proportion of their income.
Hereâs a clearer look at how billionaires keep their taxes low while continuing to grow their wealth:
1. Income vs. Capital Gains: The Tax Rate Difference
One of the most significant ways that billionaires lower their taxes is through the type of income they make.
For most people, income from wages and salaries is taxed at ordinary income tax rates, which can go as high as 37% in the U.S.
The largest part of a billionaireâs wealth, on the other hand, consists of capital gains: profits realized through the sale of assets like stocks, bonds, or real estate. Taxation on long-term capital gains is generally much lower, with a top rate of 20% in the U.S.âââfar below the possible maximum of 37% on earned income.
Rather than liquidating assets on a regular basis, billionaires hold investments for long periods of time, thus benefiting from lower tax rates. This strategy is advantageous for those who have built a substantial net worth through investments in the stock market.
2. The Power of Tax-Deferred Growth
Billionaires tend to invest in assets that are tax-deferred, meaning they donât have to pay taxes on gains until the asset is sold.
For instance, they can invest in retirement accounts like 401(k)s or IRAs or they can use tax-advantaged savings options like Roth IRAs or 401(k)s through their businesses. These accounts let their wealth grow over time without having to pay taxes on capital gains or dividends.
Furthermore, many billionaires engage in such tax-deferred strategies within their companies and investments so that wealth accumulates, sometimes for years or decades, without the immediate tax burden of selling assets or taking dividends.
3. Deductions, Write-Offs, and Depreciation
One strategy common among the ultra-rich is the use of business expenses, write-offs, and depreciation to lower reported taxable income.
While most people understand whatâs meant by tax-deductible business expenses, billionaires find a way to stretch this even further. Take the owner of real estate or a business; one can use depreciation to write off the loss in value of an asset over time, even if the market value of the property actually rises. That reduces their taxable income without reflecting an actual financial loss.
Wealthy people often donate a significant portion of their assets to philanthropy or create charitable foundations, which earn them tax deductions while allowing them some control over how the money is spent.
4. Offshore Tax Havens
Many high net worth individuals use offshore tax havensâââBermuda, Cayman Islands, or Luxembourg, for exampleâââto protect their assets, as these places have low or no taxes levied against income earned outside the country.
Setting up businesses, preserving investments, or creating trusts in these countries allows billionaires to avoid taxation in countries with high levels of taxation. This is legal under legislation, but it is also often considered unethical or immoral, especially when individuals or companies use these methods to avoid paying taxes in high-tax countries.
5. The Use of Trusts
Trusts are also a strong vehicle with which billionaires transfer wealth to future generations while also limiting estate and inheritance tax burdens.
A trust represents a legal construct that manages assets for the advantage of designated beneficiaries. Through the establishment of particular categories of trusts, including irrevocable or dynasty trusts, affluent individuals can facilitate the transmission of wealth across generations while simultaneously diminishing estate tax obligations and safeguarding assets from creditors. Such trusts can effectively secure wealth over multiple generations, permitting heirs to enjoy the benefits of the assets without facing substantial tax burdens.
6. Debt Leverage: Utilizing Assets as Collateral
Instead of selling assets, many billionaires just borrow against their wealth, using stocks, real estate, or other assets as collateral. That way, they can access liquidity without triggering a taxable event.
Such loans are generally characterized by favorable interest rates, and in numerous instances, the interest incurred can be deducted from taxable income. For instance, an individual such as Elon Musk might utilize a loan against his Tesla or SpaceX shares, directing the capital towards alternative investments or personal expenditures, all the while postponing any tax liabilities associated with the borrowed capital. This approach proves particularly advantageous during periods of rapid asset appreciation, enabling wealthy individuals to maximize their financial resources while circumventing capital gains taxation.
7. Business Structure and Tax Shelters
High net worth individuals often have a stake or a controlling interest in multiple businesses, which they structure for tax effectiveness.
For example, they may set up a family office or holding company that holds investments and business interests. These types of organizational structures allow for tax-efficient handling of income and profits.
They can even deduct business expenses, such as office supplies, salaries, or costs associated with marketing, to reduce the amount of taxable income and minimize taxes.
8. Lobbying and Political Influence
Billionaires usually use their financial power in the form of influencing tax policy in their favor. Through lobbying efforts, heavy campaign donations, and using their political connections, they help shape the laws that favor their business interests.
For instance, the Tax Cuts and Jobs Act of 2017 drastically reduced corporate tax rates from 35% to 21%, a windfall for business owners and billionaires alike. Using their political power, billionaires can negotiate good tax policies that make them wealthier and reduce their taxes.
9. Shifting of Income
This may be through the establishment of operations or subsidiaries in low-tax countries or the distribution of assets to family members who fall into lower tax brackets. For instance, parents may transfer ownership of a family business or stocks to their children, thereby spreading the tax burden across lower-earning family members.
10. Philanthropy: Tax-Advantaged Giving
Finally, philanthropy is an activity that many billionaires engage in to both advance their business goals and avoid taxes.
Making large donations to charity carries significant tax advantages; yet, the process goes beyond simply writing checks for financial contributions.
Many high-net-worth individuals create donor-advised funds or private foundations to help them retain control over the timing and amount of their philanthropic distributions while gainingimmediate tax reductions.
Through this method, they can support causes meaningful to them, influence public policy, and, in some cases, reduce estate taxes that come into effect when assets are transferred.
While these techniques are not illegal, they bring to the forefront the inequities of the tax system. These means are not easily accessible to most people, causing serious questions to arise about the reform of the current system to result in an equitable distribution of the tax burden.
Although billionaires excel at leveraging the tax system, everyday individuals can also benefit by making smart investment choices, utilizing tax-advantaged accounts, and, where possible, influencing policy to reduce their tax burdens and grow their wealth. We have more control than we think.