5 Ways to Dodge Taxes Like Bezos and Musk
Dear Rich Lifer,
In 2007, and again in 2011, billionaire Amazon CEO Jeff Bezos reportedly paid nothing in federal income taxes.
That’s according to a bombshell report obtained by ProPublica that revealed confidential tax documents filed with the IRS.
Bezos avoided Uncle Sam both years by losing more money investing than he earned from other income (stock dividends, salary, etc.).
ProPublica says it estimated what it called tech billionaires’ “true tax rate” by comparing the amount paid in federal income tax against year-over-year changes in Forbes wealth calculations.
According to the report, Bezos paid a true tax rate of less than 1% between 2014 and 2018.
During this time, his wealth soared $99 billion while he reported just $4.22 billion in income. Bezos ended up paying just $973 million in total taxes.
Another tech billionaire dodging the taxman is Tesla CEO Elon Musk. In the report, Musk paid a true tax rate of only 3.27% between 2014 and 2018.
During this time, his wealth grew $13.9 billion and he reported $1.52 billion in income. Musk ended up paying $455 million in total taxes. But for several years, including 2015 and 2017, Musk paid less than $70,000 in annual federal income tax.
According to the report, everything Bezos and Musk were doing is legal.
The most significant tax loophole exposed in the report was taking out loans collateralized against stock compensation.
It’s common practice for tech CEOs and founders to earn most of their money through stock compensation rather than salary: Steve Jobs, Larry Ellison, and Larry Page have all taken $1 salaries to minimize income tax.
But the new IRS documents show how tech billionaires are taking this a step further — by taking out a personal loan collateralized against owed stock compensation, tech billionaires avoid tax altogether rather than having to pay the capital gains rate.
Elon Musk used this strategy to take a loan out against some $57.7 billion worth of shares, while Larry Ellison did the same for approximately $10 billion worth of shares, says the report.
If you’re wondering what other tax loopholes the rich are using, today we’ll share with you five more tax tips so you can pay less in tax like the rich.
You don’t have to be wealthy to take advantage of these tips and you don’t need some genius accountant either. Here are five ways the rich pay less in taxes and you can too.
If you own buildings or equipment (even licensed software), the IRS allows for depreciation each year. That means owners of these business assets can take a deduction each year equal to an estimate of how much the asset went down in value that year.
This is why some real estate deals can be structured where depreciation of the property is greater than the income generated, basically sheltering all the property’s income from taxation.
Another nice thing about rental income is it’s not considered earned income, and therefore not subject to payroll taxes either. But there are some catches.
First, buildings really do depreciate over time. So, every few years you’re going to have to make repairs which will cost you money. Where this tax break shines is when the depreciation is recaptured.
When the asset is sold, all of that depreciation is recaptured. For example, if you bought a rental property for $300K, depreciated $100K of it, and then sold it for $400K, that $100K in depreciation is “recaptured” and taxed.
The best part is you’re only taxed at a maximum of 25%. So if your marginal tax rate was higher than that (28%, 35%, etc.), then you pocket the difference. And if your marginal tax rate is lower, it’s recaptured at your current marginal tax rate.
For the ultra-wealthy who own real estate, this provides some considerable tax savings. But anyone with a relatively high marginal tax rate can still take advantage of this tip.
If you fall into the category of lower earner, there are still some tax breaks you can leverage. First, if you have a modified adjusted gross income below $100,000, you can deduct up to $25,000 in real estate losses against your ordinary earned income. The rich can’t do this unless they’re real estate professionals.
Also, there are ways lower-earning real estate investors can pay 0% in capital gains tax, which we’ll cover next.
Another way the rich get away with paying less in taxes is they invest most of their capital. As a society, we’ve decided to encourage long-term investment of capital. We do this by lowering tax rates on qualified dividends and long-term capital gains versus earned income.
This is why there are lower tax brackets available to long-term investors and why business owners don’t have to pay payroll taxes, including Social Security and Medicare, on unearned income.
Can anyone do this? Yes, especially if you’re a low earner. In most cases, you can pay up to $0 in capital gains tax. For high earners, they may be stuck paying up to 23.8% on long-term capital gains and dividend income.
The rich have found all sorts of ways to borrow money profitably. Instead of paying for things out of pocket or selling assets, the rich will occasionally borrow money against their assets, which can save tax dollars if the interest paid is less than the tax cost.
Common ways of doing this are borrowing against the cash value of life insurance policies, borrowing against real estate, even borrowing against an investment portfolio (aka a margin loan).
This practice is not only for the rich. Anyone can borrow tax-free but you have to own some assets to make this strategy work. If you don’t own many assets, you have nothing to borrow against.
Another thing to note is delaying tax payment is not worth it if you end up having to pay back all the interest later. It’s better if you borrow against assets knowing you’ll be in a lower tax bracket later on. Or, you can even delay paying taxes altogether until the day you die taking advantage of the step-up in basis. Either way, loans are a great way anyone can pay less in tax.
Tax-Protected Retirement Accounts
The wealthy take full advantage of tax-protected accounts like 401(k)s, Roth IRAs, defined benefit/cash balance plans, 529s, and health savings accounts.
And if they have money inside non-qualified or taxable accounts, they will often move those funds through the Roth conversion process. Once inside these tax-protected accounts, their investments can grow faster and are often protected from creditors.
In case you’re wondering, this same strategy can be used by low earners. You’ll need some earned income to take advantage of these accounts. But lower earners are actually at an advantage since they can often put all of their retirement savings inside tax-protected accounts.
And depending on how much earned income you have, you may not have to deal with traditional IRA income deduction limits or Roth IRA income contribution limits, keeping the whole process simple.
The final tax break the rich take advantage of is splitting their income into salary and distributions when owning their own business. By forming an LLC or a corporation and making an S election, the business is taxed as an “S Corp.” The portion of the business’s income determined to be distributed is not subject to payroll taxes like Social Security and Medicare.
This is a great tax break for small business owners making small profits because they may actually save a higher percentage of their income. A higher earner will only save the 2.9% Medicare tax, but a lower earner may save 12.4% in Social Security tax and 2.9% in Medicare tax.
As you can see, there are lots of ways the rich have found to pay less in tax. Most tax breaks are afforded to business owners, but there’s nothing stopping you from starting a small business and taking full advantage of these five tax breaks today.
To a Richer Life,
The Rich Life Roadmap Team