How Billionaires Avoid Paying Federal Income Tax

Most Americans dutifully pay their federal income taxes, which in 2020 zap about 24% for average families making $84,201 to $160,725 annually. But our U.S tax code is structured to charge higher earners a higher tax rate, effectively making ultra-wealthy billionaires the hardest-hit come tax time.

That doesn’t stop America’s billionaires from taking creative, strategic, and sometimes questionable measures to avoid paying their federal income taxes. Rather than accepting a 37% income tax rate on all of their income above $510,301, billionaires use the following techniques to protect their assets and keep more money in their pockets.

Loopholes in the Tax Code

There are plenty of loopholes in the tax code for average Americans and billionaires alike. Here are a few of the favorites for the ultra-wealthy to utilize.

Deduction for Pass-Through Business Income

Pass-through businesses include sole proprietorships, partnerships, S corporations, and LLCs. Instead of paying corporate income tax, their income can be “passed through” to the owners, shareholders, or partners. In this way, the income is taxed at the normal individual tax rate of each individual person, rather than at a corporate level. Since the newest tax laws passed in 2017 allow individuals to deduct up to 20 percent of certain pass-through business income, the highest potential tax rate on this pass-through business income is currently 29.6%.

Wealthy Family C Corps

Some wealthy families choose to shield their income from federal taxes by forming a family C corporation. This makes it possible to pay taxes at the current corporate rate (21% in 2020), rather than the individual income tax rate (37% in 2020)

Dynasty Trusts

Thanks to the 2017 tax reform, the number of assets exempt from the estate tax increased from more than $5 million per individual to more than $11 million per individual. This gives billionaires the opportunity to set up larger long-term trusts that create income children, grandchildren, and great-grandchildren without getting hit with estate and gift taxes. As a result, these irrevocable trusts are best known as dynasty trusts.

Methods of Getting Around Taxes

In addition to tax loopholes, there are plenty of other creative ways that billionaires use to guarantee they don’t pay taxes beyond what’s absolutely necessary.

Charitable Donations

The ultra-wealthy regularly use charitable contributions to earn income tax deductions. The 2017 tax reform gave them additional incentive to do so by increasing the maximum deduction from up to 50% of adjusted gross income to 60% of adjusted gross income.

Stock Investments

The taxes that billionaires must pay when selling stocks is usually lower than the rates on wage income. Thus, wealthy Americans use stock investments to avoid annual taxes.

Tax Havens

If the movies have taught us anything, it’s that wealthy people love to use off-shore bank accounts. It’s true! Billionaires register businesses or stash their cash in countries with lower tax rates like the Cayman Islands. As a result, experts estimate that $21 trillion is currently hidden in offshore tax havens.

Does Amazon Really Not Pay Taxes?

Claiming Amazon doesn’t pay taxes is a good political sound byte, but the truth is more complicated. In 2018, even though the retail giant paid $0 in federal taxes, Amazon actually paid $1.18 billion in local, state, and international taxes. The company was able to whittle away its federal tax contribution with three significant tax breaks:

  1. Investment in research and development (a $22.6 billion contribution in 2017 alone)
  2. Investment in property, plant, and equipment ($60 billion in one year)
  3. Employee stock compensation

The bottom line? By reinvesting its profits into operations, Amazon earns so many tax credits that it doesn’t need to pay into the system come tax time.

See Also: Tax Exemptions Explained