“Trust” is a multi-streaming service fictional television series and a fictional drama about how J. Paul Getty, once the richest man in the world, and his family reacted when his grandson was kidnapped.
Prior to the kidnapping, the Getty character responds to his teenage grandson’s request for money and they discuss why he can’t give him one when they’re worth billions.
Getty explains, “It’s a self-sustaining system that never pays a dime in taxes because it never pays a dime in profits. Getty Oil is at a loss for accounting reasons, boy. At a loss. We are so poor that we could get milk brands from the (explosive) British government. “
With the highest federal marginal tax rate of 37% (excluding additional Medicare taxes) and the highest tax rate in California of 12.3%, it makes sense that every wealthy family would want to do whatever it takes to avoid losing half of their income year in taxes .
How billionaires do it
Billionaires paid just 23% of federal, state, and local taxes in 2018. In contrast to 1950-1980, when billionaires (and millionaires) paid more than 50% of federal taxes.
It was also reported just last week that with Elon Musk’s move from California to Texas, the country’s three richest men (Bill Gates and Jeff Bezos, both residents of Washington state) are unlikely to pay state income taxes.
The rich, engaged in sophisticated tax planning, understand that individual income taxes are primarily a consumption tax and that taxes are paid only on “take-away” income. Very little of their income comes from wages and they personally own almost nothing.
Much of the frugal behavior that seems strange among the rich is often actually tax related. Getty did much of his own laundry and was known for billing guests for drinks and phone calls. Steve Jobs was known for wearing plain black turtlenecks. Laundry, clothing and personal household expenses are not deductible. Mark Zuckerberg drives old cars that are valued at or below the depreciation limit. Even the amount of ransom Getty agreed to pay for his grandson personally was the legally deductible amount.
Warren Buffet, who is valued at around $ 85 billion, said he paid just 17.4% in income and wage taxes last year, while the 20 people in his office paid more than double that. Still. The buffet lives in the same house he bought in 1958 and has breakfast at McDonald’s. His house and cheap breakfast don’t cost a lot of money after taxes.
How much do most people pay?
If we “normal” people couldn’t pay any income tax, what impact would that have on our wealth? For example, a two-income household earning $ 100,000 would have paid $ 8,600 (rounded) and $ 2,800 (rounded) with a standard deduction with no children in 2020. If he could save that $ 11,400 annually and earn 6% a year in 30 years, they would have made over $ 900,000 in additional savings (due to compound interest). It’s not a billion, but it’s still significant.
But wait. Notice that the effective federal and state combined tax rates for our example pair are 11.4% ($ 11,400 tax / $ 100,000 income) and, like the billionaires, paid far less than the highest marginal rate of 49.3%. This is because the couple did not earn enough to pay the maximum marginal rate. They would only pay the highest marginal rate of 37% if their taxable income was over $ 622,000.
A taxpayer’s effective tax rate (or average tax rate) is the percentage of income they pay in taxes, as in the example above of 11.4%. In contrast, a taxpayer’s marginal tax rate is the tax rate charged on their last dollar income. Taxpayers’ effective tax rates are lower – usually much lower – than their marginal tax rates.
So when you hear on the news that the highest marginal tax rates have gone up or down, you understand that those rates apply to the highest income earners and generally don’t apply to most of us.
How much do i pay
To find out what effective and marginal tax rates you currently pay, print out a five-year summary report from your tax program or ask your tax advisor to print one out for you. The report provides a summary of your income, deductions, and taxes paid over the past five years, as well as the impact of the Tax Reduction and Employment Act (TCJA) 2017 on your taxes in 2018.
Can normal people plan?
Returning to our example, is there anything our couple could do to reduce their taxes, and at 11.4% of total state and federal taxes, is it even worth doing any tax planning?
What if they bought a home? If we base the home purchase amount on taxable income, buying a home is unlikely to lower taxes. With the change in tax law in 2017, the standard deduction was increased to $ 24,000, which left 90% of Americans unable to break down.
What if they had a couple of kids? You would save $ 1,000 in tax credit for each child. Would it be worth it to contribute to your 401 (k)? At their tax rates, every dollar that contributed to their 401 (k) would translate into a tax saving of 11.4 cents or less.
With that in mind, would I advise you not to buy a home or contribute to your 401K? You should continue to consider these strategies but especially for the other financial benefits like building equity and saving for retirement.
Tax planning in the upper and middle tax bracket
The traditional benefits of tax planning of lowering your income through tax-privileged or small business investments, or increasing your deductions by owning a home or donating to charity, increase the higher your marginal rate. Therefore, for those of you who are earning more than the median amount, tax planning is still essential.
For higher income clients, I recommend speaking to a financial advisor about budgeting techniques and cost tracking to help limit personal expenses. Your advisor or CPA should at least be able to review your personal financial statements and budget with you. Find out what is and what is not tax deductible and plan accordingly.
Don’t worry too much about tax changes
When I hear my clients or friends on social media fear that their taxes will rise with a change in administration or party in power, I usually want to give them a socially distant hug and tell them those in charge are no not so concerned about collecting more from us.
The new government has several issues on its agenda that are more important than repealing the 2017 TCJA or major changes to tax law.
The reality is that only two major tax laws have been passed in the past 40 years. The Biden tax proposal claims it would only increase the tax on those who earn more than $ 400,000 and most proposals are unlikely to go ahead. It is more likely that Congress, this administration, and the next administration will phase out most of the existing rules and phrases in 2025. Consider this one less problem that you don’t have to worry about as 2020 finally comes to an end.
Michelle C. Herting, CPA, ABV, AEP, specializes in estate, trust, gift, and business valuations. She has three offices in Southern California and is President of Inland Southern California’s Charitable Gift Planners.