It’s no secret that people with money like to shield their earnings from the IRS. What is often a secret, however, is how and where they do it.
1 . Playing hide-and-seek with Uncle Sam:—
No one enjoys paying taxes. So, no matter your income level, searching for new tax breaks can be a wise use of your time and energy. The ultra-wealthy, however, sometimes take steering clear of taxes to another level. Former treasury secretary Lawrence Summers, along with finance professor Natasha Sarin, recently released a research paper with some eye-opening claims.
According to Summers and Sarin, the top 1 percent of taxpayers are projected to avoid more than $5 trillion in taxes between 2020 and 2029. Of course, the legal tax-reduction strategies used by rich people are worth reviewing and utilizing when possible. But it’s not a bad idea to learn about the illegal methods as well—so you can avoid them and their potential consequences. While we’re on the subject, check out some of the craziest tax deductions ever claimed.
2 . Business deductions:—
Starting a business (or multiple businesses) is a common way the rich aim to reduce their tax liability. But you don’t have to be wealthy to use this method, notes Jon Dulin, founder of Money Smart Guides. If you’ve been wanting to give entrepreneurship a try or even formalize a side hustle, this may be a good option.
Of course, you have to go through the proper channels first: Creating a legal business entity typically requires a simple visit to the websites of your Secretary of State and the IRS. Once you establish your business, tax deductions are just one of the benefits you may be able to enjoy. “For starters, you can write off losses the business incurs in the beginning and then use business expenses to offset business income to lower taxable income,” Dulin says.
“Additionally, you can put money into tax-deferred accounts, like solo 401(k) plans, which allow the business owner to save a lot more than traditional 401(k) plans since you are contributing both as the employer and the employee.” Learn the money mistakes even financial experts make.
3 ..Hiring family members:—
Another tactic the rich often use to shield income from taxes requires getting the family involved. If you have a business, you can use this strategy to your advantage, too, by hiring your spouse or your children and paying them a salary. The IRS even says that “one of the advantages of operating your own business is hiring family members.”
So, how does this help you, exactly? “Your business gets a write-off,” Dulin explains, “and [your spouse or child] can put the money into tax-deferred accounts. These accounts may further protect the money from taxes.” Just be sure to follow the rules, like withholding any necessary payroll taxes.
4 . Vacation homes:—
Vacation homes are another way the rich may opt to shield cash from Uncle Sam, says realtor Bryan Vance, founder of Bucks & Cents. Vance explains that “with the recent increase of the standard deduction, a lot of homeowners no longer itemize popular items such as mortgage interest on their primary residence.”
State and local income taxes, along with property taxes, are limited to $10,000 if you opt to itemize. “But that’s not the case with a vacation home, should you choose to let others stay there,” Vance says. Rent your vacation house for less than 14 days a year and the rent you earn is usually tax-free. Rent out the house for more than 14 days a year and you can deduct expenses (mortgage interest, property taxes, maintenance, depreciation, etc.).
5 .Real estate tax deferment:—
When the wealthy sell an investment property, like a vacation home, they may use another tool to help them pay less to the IRS. Jim Wang, the founder of Best Wallet Hacks, explains how a 1031 Exchange may help you put off the cost of capital gains taxes when you sell an investment property. “If you purchase a ‘like-kind’ property, you can defer capital gains on the sale of investment real estate,” Wang says. “The logic behind this deferment is that you’re swapping one investment for another, so the IRS lets you defer the gains.”
If you want to defer your gains and postpone paying taxes on them, you’ll need to complete a 1031 Exchange. “Eventually, you will have to realize those gains, but until then, you can keep exchanging and grow your real estate portfolio without the pesky tax hit after every sale,” Wang notes. At present, there’s no limit on the number of times you can take advantage of this special tax deferment. These are the 13 things rich people never waste their money on.
6 . Life insurance:—
Permanent cash value life insurance, like whole life insurance or universal life insurance, is another place the rich put their money. Chris Abrams, the founder of Abrams Insurance Solutions, says life insurance is an excellent way to eliminate the tax and market risk present in other assets or investments.
“Contributions are not limited by the government, like [with] 401(k)s and other qualified plans,” Abrams explains. He also points out that when you take money out of your life insurance policy, you can remove it as a tax-free loan against your policy’s death benefit. “Since it is a life insurance policy, there is still a death benefit if something unexpected happens.”
Of course, there is some risk involved. If you pass away while you still have an outstanding loan against your life insurance policy, the insurance company will take the debt you owe out of your death benefit before distributing any remaining funds to your beneficiaries. Also, if you borrow more than you paid into the policy in the form of premiums, those funds may be subject to income tax. While we’re on the subject, learn which insurance policies aren’t worth the money.
7. Offshore accounts:—
No list of the many ways the rich hide their money would be complete without mentioning notorious offshore bank accounts, such as those commonly used in the Cayman Islands, Switzerland, and Singapore. According to Pedro Nicolaci da Costa, writing for Business Insider, the ultra-wealthy currently have around 10 percent of the global gross domestic product (GDP) hidden away in offshore tax-havens.
Such tax havens, which often enable the wealthy to get out of paying their fair share of taxes, can contribute to income inequality in both the United States and around the globe. And here’s a particularly sobering tidbit: By 2017, the United States had returned to roughly the same income inequality levels seen in this country during the Great Depression.
While offshore accounts aren’t illegal in and of themselves, they cross the line when people set them up for the purpose of tax evasion. FYI, these are the states with the largest race income gap.
8. Shell companies:—
You’ve likely heard about shell companies, but what are they, exactly? A shell company is a business without operations or sizable assets of its own. Yet despite their shady nature, shell companies are sometimes legal. For example, an American business might establish a shell company when it wants to operate manufacturing plants in a foreign country.
However, they frequently cross the line. An anonymous shell company, for example, can hide the assets of a business or an individual from the IRS, law enforcement, a spouse, creditors, and more. According to the non-profit organization Americans for Tax Fairness, shell companies and other tax loopholes help U.S. corporations avoid paying as much as $90 billion per year in taxes to the IRS. Taxes can get people into hot water—just check out these 8 presidential tax scandals.
9 . Municipal bonds:—
Believe it or not, buying bonds from the government is a common and legal way for the rich to avoid taxes. “Governments (local, state, and federal) issue municipal bonds to finance large projects, such as building a new school, highway, or public park,” says the founder of SimpleMoneyLyfe.com, who simply goes by Drew.
“Municipal bonds are safe investments that command a decent interest rate; however, the ultra-wealthy often invest in municipal bonds because earnings are almost always exempt from federal taxes.” People with lower incomes and net worths can invest in municipal bonds as well, but often you’d be better off finding a taxable bond that offers a higher return rate instead. Check with your financial adviser if you have questions on any specific investment strategies.
10 .Sparkling assets:—
Natalie Pine, a certified financial planner and managing partner with Briaud Financial Advisors, sheds light on a shady practice that some dishonest rich people use to stiff the IRS. This illegal method starts with buying expensive jewelry. “I have heard of people buying diamonds, in particular, and passing those on to children without filing any gift tax return or estate tax return,” says Pine.
“They are small items that transfer easily unnoticed. There are no specifics listed [on the inventory] for the IRS to refute unless they audit the individual/couple.” Of course, Pine does not advise breaking the law in this way to avoid taxes—under any circumstances. “To be very clear,” she says, “we have never done this, nor do we recommend it.”
11. Donor-advised funds:—
People know that donating to charity can both benefit others and help you lower your taxes. Donor-advised funds (DAFs) are a next-level approach to charitable giving that can offer even bigger tax benefits. “Donor-advised funds are like a personal charitable savings account used by the wealthy,” says Scott Henderson, an accredited financial counselor and the creator of SimpliFinances.
“The money you contribute to a DAF is tax-deductible, and the money has to go to a charity eventually. For example, you could contribute $10,000 to a DAF this year and receive an immediate tax deduction. But you could let the money sit in there until 2030 and then choose to send it to a charity of your choice.”