12 Tax Secrets of the Wealthy - 2019
When I was living in Honolulu about 20 years ago, I remember a local infomercial where a guy was talking about how the wealthy understand the tax laws and are able to take advantage of them to increase their wealth. He referred to the different pages of the IRS 1040 tax return as "rooms." Some of the rooms were green and made you money, while others were red and cost you money. It was called "Tax Secrets of the Wealthy." His message was rather simple: It doesn't matter how much you make, it's how much you keep that counts. His message still rings true today. If you work for a paycheck, most likely your main opportunity to reduce your taxes is with 401(k) or IRA contributions and a mortgage deduction. With the recent tax legislation, mortgage deductions will be worth less in the future with the new limitation on the amount that you can deduct. The 401(k)/IRA deduction is good, but you will pay a lot of taxes in the future if your investments do well.
The wealthy, on the other hand, have many strategies to reduce taxes:
Use a team of experts (i.e., tax / estate attorney, tax accountant) to structure investments and their ownership to minimize taxes and liability, maximize returns and optimize estate planning
Own one or more businesses, which allow for deduction of business expenses and payment of a salary to the owner (also a business expense)
Own real estate through limited liability entities and lease to their company(ies), which provides a tax deduction to the business (rent), minimizes taxable income at the entity owning the property due to depreciation and ownership expense deductions that offset the rental income, and allows for ultimate sale of the underlying business while retaining control over the real estate
Change ownership of their companies to take advantage of tax rates; recently many companies are converting from "S" to "C" Corporations to take advantage of the new lower 21% "C" corporation tax rate, which is less than the top individual tax rate (which is also the "S" corporation tax rate) of 37%
Beginning in the 2018 tax year, the new tax law provides small business owners with a 20% deduction against business income. It’s officially referred to as the Section 199A deduction, and it applies to small businesses, other than “C” corporations. There are income limits against which that deduction can be taken.
Invest in tax-preferred investments such as municipal bonds (tax free for Federal and possibly for State as well if issuer is state of residency, which can meaningfully boost returns)
Invest in stocks that pay qualified dividends or generate capital gains (taxed at 0%, 15% or 20% rate depending on tax bracket, which is much lower than corresponding tax bracket rates for ordinary earned income)
Invest in oil/gas/affordable housing partnerships, which have various tax benefits including deferral of taxes on cash distributions and income tax credits
Own investment real estate, which provides tax benefits due to depreciation and operating expense deductions that offset rental income, thereby reducing or eliminating taxable income, while providing positive cash flow and building wealth through appreciation of property and leverage (mortgage that reduces your initial cash investment)
Sell investment property using a 1031 exchange transaction, which allows for the deferral of taxes and the use of all of the sale proceeds to buy a new, more valuable investment property
Invest in alternative investments using leverage (debt), the interest cost of which can be deducted against the investment income and generating infinite returns using "other people's money"
Use life insurance to fund a portion of retirement needs and for estate planning (death benefit is tax free and life insurance loans to fund retirement are also tax free, but reduce death benefit)
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