Special tax treatment for the wealthy
May 11, 2019
Do wealthy individuals get "special" treatment when it comes to paying taxes?
It can often seem that way.
Last month Amazon reported that it will not owe any federal taxes for the second year in a row. This is in spite of earning $11.2 billion last year. And Warren Buffett revealed his 2016 tax returns showing an effective tax rate of just 16% on $11.6 million in gross income.
In comparison, I have physician clients earning $1 million in gross income, that without any tax planning would pay an effective tax rate of about 40%.
How does this happen? And how can you get the same "special" tax treatment, too, without being a billionaire?
Jeff Bezos, the founder of Amazon, is the world's richest person on paper. But here's the catch, he only takes home an annual salary of $81,840, putting him in a middle-class tax bracket.
Amazon is a business, and because of this they're able to avoid taxes by reinvesting their profits back into the business. They continually spend more on Research and Development than any other company in the country, which in turn reduces their tax liability.
Warren Buffett is worth an estimated $83 billion, but for 2016 he only took home $11.6 million in income. His net worth comes from owning shares of his company, Berkshire Hathaway, not from earning a high income in wages.
He reportedly donated $3.5 million to charity and had another $5.5 million in deductions, leaving him a total tax liability of $1.85 million in federal income taxes.
So, what's the difference between you and billionaire Bezos or Buffett?
It's not that much. The same tax code that they are taking advantage of is taking advantage of you! The truth is, you don't have to be a billionaire to enjoy "special" tax treatment, but you do need to change the way you operate and the way you think.
What can you do?
#1: Own a business. What we learned from Amazon is that it pays big time to own a business. Reinvesting profits back into your business is one of the easiest ways to increase your long-term wealth and avoid paying taxes. Here's the thing, when you own a business, there may be more opportunities to take tax deductions than you realize.
#2 Meet with your tax advisor. Look for ways to convert personal expenses into legitimate business expenses. Bring receipts for all of your purchases with you when you meet your Tax Pro. Do this outside of tax season and before the end of the fourth quarter. Go through the list together looking for charges that could be considered business expenses.
A good example might be a magazine subscription? It can be a deduction if you keep it in your lobby for clients to read.
Education expenses can often end up being business expenses.
Travel when related to your business is another great deduction.
And don't forget the home office deduction. If a room in your house is used exclusively for your business, then you have a tax deduction.
#3: Look for ways to shift your income. Creating an S Corp is the most common way to "shift" your income.
With an S Corp, your business must pay you a reasonable wage, that is the same that you would pay someone else to do the job you do in the business. You will pay ordinary income and self-employment taxes on that income. But then, you can take the rest of the business's profits as a distribution which is not subject to the 15.3% self-employment tax.
Another way to "shift" a portion of your income and save on tax is to create a second business entity. You might have an S Corp for operations and form a C Corp for another division of your business or to provide services for your business. You'll pay less on the first $50,000 of income for the C Corp than you would as an LLC or S Corp.
Think about what you are doing
The most important rule is to never spend money in your business without having a plan. Don't just do things in the name of saving tax. It doesn't make sense to spend a dollar to save 30 or 40 cents. Check it out, do the math, then make a decision. If you can save tax and still be frugal, then that's what you want to do.
"Special" tax treatment is real.
There are many ways to get special treatment. The key is to be proactive and educate yourself.
Here's what to do next:
1. Reinvest to grow your business. Even if it means creating new markets and expanding into new areas. Once upon a time, Amazon only sold books. Now they sell everything and do everything.
2. If you're not already in business, start one. You can even turn a hobby into a business and then you'll have plenty of business deductions.
3. Set up a time to meet with your Tax Advisor. Go over your expenses together and see how many you can tie to the business. Let your Tax Advisor determine if it's deductible or not.
4. Finally, don't forget to take action. Often, we will hear or see something and say to ourselves, "yeah, I'm going to do that," but then nothing happens. This time, let's make it happen!
Jay Thompson is a Business Consultant with the CSU Bakersfield Small Business Development Center. The CSUB SBDC provides premium, one on one, no cost consulting to small business owners in Kern, Inyo and Mono Counties. For more information visit their website at www.csubsbdc.com.