Tax Secrets of the Wealthy
Tax (Photo credit: 401K 2012)
When I was living in Honolulu about 20 years ago, I remember a local TV show where this dude was talking about how the wealthy understand the tax code and are able to take advantage of the tax laws to increase their wealth. I never fully understood his message until very recently: It doesn't matter how much you make, it's how much you keep. His message still rings true today. If you work for a paycheck, most likely your only opportunity to reduce your taxes is with 401(k) or IRA contributions and a mortgage deduction. The net result is that you still pay a lot of taxes now and you will pay a lot of taxes in the future if your investments do well - your reward for being a good investor. Your house, I'm sorry to say, is not an investment - it's just a place to live.
The wealthy, on the other hand, have many strategies to reduce and defer taxes. They:
Use a team of experts (i.e., attorney, accountant) to structure investments and their ownership to minimize taxes and liability, maximize returns and optimize estate planning
Own one or more businesses, which allows for deduction of business expenses and payment of a salary to the owner (also a business expense)
Invest in tax-preferred investments such as municipal bonds and high dividend-yielding stocks
Invest in oil/gas partnerships, which have various tax benefits including deferral of taxes on distributions, income tax credits and also hedge against inflation
Own investment real estate, which provides positive cash flow and tax benefits due to depreciation and operating expense deductions that offset rental income, as well as a hedge against inflation
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 investment property
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 productive assets
Invest in alternative investments (accredited investor)
Use leverage (good debt) in investing in real estate and to create positive arbitrage - i.e., earning a higher after-tax rate of return than they are paying on the money
Use life insurance to fund a portion of retirement needs and for estate planning
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