(This article originally appeared on Entrepreneur)
Just last month it was revealed from an investigation of IRS data by media platform ProPublica that — surprise, surprise — the wealthiest of the wealthy (Bezos, Buffet, Musk, etc.) did not pay their “fair share” of income taxes over the past 15 years. What do we mean by “fair share?”
The bipartisan Tax Foundation says that the average federal tax rate for all taxpayers, after you take into considerations deductions, credits and exemptions, was 13.3% in 2018. Bezos, in 2017, paid no taxes. Elon Musk’s “true” tax rate was about 3.4%, and Warren Buffet’s was 0.1%, according to the ProPublica report.
Because I’m a certified public accountant, people often ask me (usually after one or two beers): How can this be? How can these wealthy-beyond-belief men pay almost no taxes at all? They’ve got billions, right? Shouldn’t they be paying their “fair share?”
These questions are certainly reasonablem but before we let our emotions take hold, let’s understand why they pay so much less taxes, relatively, than the rest of us. There are a few tricks that are used. But their biggest weapon is debt.
Just because they have billions in the bank, it doesn’t mean those billions are taxable. When our stocks, mutual funds and investment accounts rise, we don’t pay any taxes on those increases because they’re unrealized gains. We would pay taxes if we realized those gains by selling those assets. But most of us don’t — at least not regularly. And neither do the very rich. So just because Bezos may add a few billion dollars to his wealth year over year, that money isn’t income. Therefore, it’s not taxable.
These assets provide a great way to avoid income tax because they can be used as collateral. And that’s what these guys do. They borrow against their assets to fund their lifestyles. Just like unrealized gains aren’t taxable, neither is debt. When a mortgage company gives you $300,000 to buy a house, that’s not income. You owe that money. You don’t pay taxes on it when you receive it.
So what the very wealthy do is borrow. Maybe it’s a few millions bucks a year. That’s a lot of money to you and me, but to a multi-billionaire, a few million bucks is not a big deal. In order to make their monthly debt payments, the wealthy oftentimes take a salary from their business. That salary is taxable. But again, it’s a paltry sum compared to the increase in their overall wealth.
Does the debt ever get paid back? Maybe. It could be paid off at death (by then, who cares what the amount owed is?). But more than likely it’s part of a trust that carries forward forever in the future to next generations.
This is something that more business owners should know about. Why? Because if we’re heading towards a potentially higher tax environment (as it seems that we are in 2022), maybe it makes sense to cut down our compensation and instead borrow on our assets to fund certain expenditures. Those assets could be our savings or it could be against the value of our companies. Then we could take less taxable compensation as a result.
I’m not saying we should go in over our heads. The key is keeping things relative. For Jeff Bezos, a few million a year borrowed is a very small part of his overall worth. That’s not the case for most of us. But it’s possible that, if you’re worth a million or a few million dollars, then borrowing a hundred grand or so for a few years would help you reduce your tax bill in the same way. That’s up to you.
Should the system change? Is it unfair? Should there be a “wealth tax?” That’s all up for discussion. But at least now you know why these people don’t pay their “fair share.”