By Lee Sherman
What do Jeff Bezos, Elon Musk, and Warren Buffett have in common? While besides being among the world’s most wealthy men and successful entrepreneurs, they also paid nothing in federal income tax by using the exact same tax tactic.
According to information obtained by ProPublica, Bezos, the founder of Amazon, and the world’s richest man managed to completely avoid taxes in 2007 and 2011. Musk, founder of Tesla, and the world’s second richest man did the same in 2018. Others that have done this multiple times include former NY mayor and presidential candidate Michael Bloomberg, billionaire investor, Carl Icahn, and George Soros.
Some people may have been similarly shocked when the New York Times revealed in September, 2020, that Donald J. Trump paid just $750 the year he was elected President. More cynical types will understand that the wealthy pay income tax on only a small fraction of the amount they earn. The US tax system is designed to be proportional, with the highest tax rate, 37%, affecting those who earn over $628,300 currently. Most Americans are familiar with this. If you earn more you pay more. But the highest earners are adept at avoiding these taxes. One way is to use asset-based lending. Asset-based lending lets you borrow money by using your existing assets as collateral. The trick is not to sell your assets when you need cash, (in which case you’ll be faced with capital gains taxes), but to hold onto them for as long as possible and borrow against the assets. This works for wealthy people because they can borrow when interest rates are low and use that money to invest further. The 1% therefore have more working capital than less affluent Americans. For them, the more you have, the more you can make. This is how the rich get richer.
What are capital gains taxes?
Capital gains tax is a tax on the profits earned from the sale of assets such as stocks, real estate, businesses and other investments. The US government consider this taxable income. But the important takeaway is that capital gains are only taxed when the asset is sold. They are by far the biggest contributor to a wealthy person’s taxes.
Since wealthy people know this, they hold onto their assets longer to avoid paying capital gains tax. The numbers bear this out. This is because the highest capital gains rate for the wealthy is 20% and some of the wealthiest Americans are able to borrow at less than 5-10% from banks. The larger their portfolio, the better the interest rate. When you hear of a corporate executive taking either no or a nominal salary, and getting paid only in stocks and dividends, this is not something they are doing out of the goodness of their hearts, but is in fact part of a long-term strategy asset managers refer to as income modification. The wealthy only pay taxes on this income when the options are executed.
Borrowing money from existing assets in order to lower your taxes may sound shady at first. But it’s not only perfectly legal, it’s something you can also use. It’s why refinancing your home can work, but only, if you do what the ultra-rich do, and reinvest the money in other income producing activities such as investments, say wealth managers.
By working with both a financial advisor and a tax advisor, or in some cases when a firm offers both services, just one firm, you can determine if this tactic can work for you as well.
Lee Sherman is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Lee is an experienced journalist and editor with over 30 years of expertise with a significant history of writing in the personal finance and technology arenas.