Imagine working hard, generate income and then pay your taxes, and see a huge chunk of your paycheck disappear to government deductions. Meanwhile, billionaires (despite their massive fortunes) often pay a far lower true tax rate than the average worker. Some even pay nothing at all. How is that possible?
It’s not because they’re breaking the law (well, most of them). Instead, they use perfectly legal loopholes, tax havens, and clever financial tricks to minimize what they owe.
In this article, we’ll uncover the strategies the ultra-rich use to legally shrink their tax bills and why the system allows them to get away with it.
Before we continue, do take note of the key terms used such as "true tax rates" which aims to capture the percentage of an individual's wealth growth that they pay in taxes.
Source: ProPublica
How much do Billionaires "evade" taxes?
While the term "evade" might imply images of illegal activity, most of the tax strategies employed by billionaires are 100% legal, even if they exploit loopholes in the tax code. Investigations conducted by reputable sources like ProPublica have revealed that many billionaires pay effective tax rates far below their statutory rates. Put simply, the statutory tax rate is what the law says you should pay, whereas the effective tax rate is what you end up paying after deductions and loopholes.
For example, while the top US income tax rate can reach 37%, some billionaires end up paying around 2-5% when tax deductions, capital gains treatment and other financial maneuvers are taken into account.
Analysts have calculated that if one were to consider the overall growth in wealth, including both realized and unrealized gains, the tax contribution of billionaires could be as low as 1-2%. This is a significant contrast to what many middle-income taxpayers experience, where a larger proportion of their income is immediately taxed at higher rates.
The Art of Tax Minimization
1. "Buy, Borrow, Die"
The concept of "buy, borrow, die" was developed by Professor Edward J. McCaffery in the 1990s to explain how people get rich and stay that way. This is one of the most ingenious methods billionaires use to avoid triggering capital gains taxes and they do it by borrowing against their appreciated assets instead of selling them.
When an asset such as stocks or real estate increases in value, selling it would generate a capital gain, which is basically a profit that can be taxed. So instead of selling, many ultra-wealthy individuals keep their assets intact, allowing them to appreciate without worrying about it being taxed. Rather than liquidating these assets, they use them as collateral to secure loans, taking advantage of the fact that loans are not considered taxable income.
The "Buy, Borrow, Die" cycle goes as follows.
- Buy: Initially, the billionaire invests in assets that are expected to appreciate over time such as stocks, real estate, art and collectibles
- Borrow: As the value of these assets grows, they become collateral for loans. This borrowing provides liquidity while the asset’s appreciation continues unchecked because no sale has occurred. Essentially, the wealth is leveraged to generate further opportunities without incurring taxes.
- Die: Upon the investor's death, a significant tax advantage comes into play. The heirs receive a “step-up” in basis. This means the asset’s cost basis is reset to its market value at the time of death. If the asset is later sold, the capital gains tax is calculated based on this new, higher value—often dramatically reducing or even eliminating the tax burden on those gains.
Naysayers argue that this strategy contributes to wealth inequality. As ordinary workers cannot easily access such low-tax borrowing against assets they don’t already own, the ultra-rich are able to accumulate and preserve vast fortunes with minimal tax interference. 2. Offshore Accounts & Tax Havens
Offshore accounts and tax havens are financial arrangements that enable individuals and corporations to shelter assets from higher domestic tax rates by utilizing jurisdictions with minimal or no taxation. These methods, while legal, often raise ethical and transparency concerns.
Offshore accounts refer to bank accounts/investment portfolios held outside one's home country, typically in jurisdictions offering favorable financial privacy and tax benefits. The key purpose is to manage wealth, access international investment opportunities and to reduce tax liabilities.
Tax Havens refer to countries that impose minimal or no tax on foreign income and offer financial secrecy, which are strict confidentiality laws that protect account holders' identities and financial details.
Common examples of offshore accounts and tax havens include Cayman Islands, Luxembourg, British Virgin Islands and Switzerland.
However, it is not 100% secure as there has been notable cases and investigations such as the Panama Papers Leak in 2016 which exposed how wealthy individuals and public officials used offshore entities to conceal assets and evade taxes.
There has been substantial global efforts to address offshore tax avoidance. Organizations like the Organization for Economic Co-operation and Development (OECD) have developed frameworks to promote transparency and combat tax avoidance, including the Common Reporting Standard (CRS) for the automatic exchange of financial account information.
3. Exploiting loopholes and legal grey-areas
Billionaires often navigate the intricate US tax code to significantly reduce their tax liabilities through various legal strategies that exploit existing loopholes and leverage favorable tax treatments. A prominent example is the preferential taxation of capital gains compared to ordinary income.
To better understand this, one must understand the key differences between capital gains and ordinary income taxation.
Capital Gains: Profits from the sale of assets held for more than one year are classified as long-term capital gains and are taxed at rates of 0%, 15%, or 20%, depending on the taxpayer's income level.
Ordinary Income: Wages, salaries, and other earnings are taxed as ordinary income, with rates ranging from 10% to 37% based on income brackets.
This disparity incentivizes investors to hold assets longer in order to benefit from the lower tax rates on their gains.
A flaw in the Tax System?
In the end, the tax strategies of billionaires aren’t just about clever accounting. They reveal the fundamental flaws in our tax system. While many of the methods they use to minimize their tax burden are legal, they often create a scenario where the ultra-wealthy pay far less than what they arguably should.
As the gap between the rich and the rest continues to widen, it's clear that reform is necessary. If we want a tax system that is truly fair, it’s not just about what’s legal but what's right. The time has come for policymakers to close these loopholes and ensure that everyone, regardless of their wealth, contributes to the well-being of society. Until then, billionaires will continue to use the system to their advantage, and the rest of us will be left paying the price.
