Americans pay taxes every year to ensure the maintenance of the communities around us and the achievement of new developments.

However, you might wonder why the rich don’t always pay as much in taxes as the middle class. While this sounds unfair, a clear explanation can help you understand why it makes sense and what you might be able to do to take advantage of the same loopholes. We’ll explain how wealthy Americans use different strategies to lower their tax effortlessly.

Key Takeaways

• While the upper class is expected to pay more in taxes in principle, middle-class Americans actually pay more on average.
  
  

• Wealthy taxpayers have multiple ways to “cheat the system,” which results in them paying less in taxes each year. This includes using and transferring tax money to hide it from tax reports.
  
  

• Middle-class taxpayers can also use strategies to help lower their taxes. These can be simpler tasks compared to the tactics the top 1% use, such as filing a depreciation claim with the Internal Revenue Service (IRS).

  
  

Why Do the Rich Pay Less Taxes?

According to the IRS, the more money you make, the more you should owe in taxes. However, statistics from recent years tell a different story. In 2021, the 400 richest families in America paid an individual tax rate of 8.2 percent, whereas the average American taxpayer paid 13.3 percent. Here are some explanations for this.

Loopholes

With all the money millionaires and billionaires have, they can use loopholes to make their wealth nontaxable. Rich taxpayers don’t classify their money as traditional income, which is why they owe smaller amounts than expected.

Transferring of Funds

Upper-class taxpayers transfer money safely and legally to avoid paying a large percentage in taxes. There are limits to how much money you can transfer to other people or businesses, but those who take advantage of transfers do so without breaking any legal boundaries.

Trustworthy allows you to store and manage all your important tax documents. You can also keep copies of deeds, titles, mortgage payments, and other proof of ownership on file whenever you need to file tax refunds.

Tax Strategies the Wealthy Use to Avoid Paying Taxes

Because upper-class taxpayers have more than enough money to spare, they have more resources on hand to create loopholes and reduce the money they owe each year. To avoid paying hundreds of thousands or millions in taxes, wealthy taxpayers practice one or more of these tactics to keep most of their money from the IRS.

Tax Havens

Rich taxpayers rely on countries known as “tax havens” to help reduce taxes every year. The taxpayer purchases property or runs a business in the tax haven country and “hides” the money there. 

When this happens, the IRS doesn’t notice this money, but the taxpayer still possesses it, taking advantage of the country’s protection laws. Examples of tax haven countries include Luxembourg, the Bahamas, and Singapore.

Jovana Vojinović, Director of Business Development at Nomad Capitalist, explains:

“A tax haven is a place or a jurisdiction that has either a very low or zero headline tax rate. This can help you personally and can help your company reduce a tax bill…

Countries that do not necessarily have a headline tax rate of zero or one or two percent can also serve as a tax haven if used properly…”

Additionally, she states:

“In most of the cases, they also have very good asset protection laws, especially when it comes to trusts or holding companies. They are not going to be places that will easily give out information about you or what is held in the trust or holding company to any other country. Because of those factors, many people see those as places where you can effectively hide your money and no one will know about that.” 

Investments

Typically, there are two types of income, though only one helps determine how much a person owes. While the typical American can only get income through wages, the rich can receive income through investments. These investments include capital, rent, dividends, and interest. 

This is one of the main ways millionaires and billionaires use their money to avoid having it count toward their taxes.

Private Foundations

Wealthy taxpayers can set up private foundations to transfer money to. When this happens, money is moved away from the donor’s estate. Because the money technically isn’t in the taxpayer’s possession, it isn’t subject to state or federal taxes. 

Depreciation

High-income individuals can own many things, from buildings to cars to collectibles, which can depreciate over time. 

Depreciation measures the decreasing value of an asset due to wear and tear, neglect, or damage. When reporting depreciation to the IRS, the value of each asset is recalculated. For instance, boats and yachts can depreciate on average by 40% after five years, and all it takes to lower taxes is to provide evidence of depreciation.

What Tax Strategies Are Available to Lower Taxes for Regular People?

There are ways for middle-class taxpayers to achieve lower taxes as well, so not every loophole in tax laws is just for the top 1%. 

While you might not get major tax savings, they are easy to do for the standard taxpayer without having to take extreme measures such as moving, setting up a foundation, or owning property overseas. Here are some clever ways you can reduce the taxes you owe for next year:

Marital Deduction

The gift tax regulations can benefit married couples by exchanging rights to money and property between the two partners. As long as you and your partner are U.S. citizens, you can exchange as much property or funds as you’d like without getting issued a gift tax. For foreign partners, the gifting limit is $149,000 per year.

Claim Depreciation for Your Car

One way to reduce your own taxes is to mention to the IRS the depreciation your car received. You can do this by calculating the mileage and providing proof for all the times the car needed to be repaired. 

Trustworthy can help you prepare to file car depreciation with the IRS. Gather all of your receipts and insurance information on your car to organize everything about your car in one secure place.

Set Up An IRA

An IRA (individual retirement account) is great to invest in towards retirement. Essentially, you save money that the IRS can’t touch. Traditional IRAs are easy to set up, as many companies have each employee auto-enrolled in one. Roth IRAs, however, are better with taxes. If you need to withdraw money from a Roth IRA, this account won’t come with a tax.

See If You Qualify for a Tax Credit

For those on track to make less than $66,819 in 2024, you might be eligible for an earned income tax credit (EITC). This credit might be attained depending on your income, marital status, and number of children in your family. You can get a tax credit of up to $7,830.

Frequently Asked Questions (FAQs)

How much do rich people avoid in taxes?

The top 1% of American taxpayers pay a lower tax rate than the lower 50% of American income earners. Although rich people often use several legal strategies to alleviate money owed to the IRS, each person’s financial situation is unique, and the taxes will vary.

How much do the top 1% pay in taxes?

In recent years, the top 1% of American taxpayers made up around 40 to 43% of the total tax revenue collected by the IRS. The top 1% is classified as those who earn more than $561,350.

Which country pays the least tax?

Bermuda pays the least tax. There are no taxes on income, profits, capital, or dividends in Bermuda. The country regularly issues Tax Assurance Certificates for certain trusts and companies, typically making the business immune to taxes for several years. Other countries that don’t have income taxes include the Bahamas, United Arab Emirates, and Monaco.

Which states pay the least tax?

Alaska pays the least in taxes. For property, income, business, and sales taxes, Alaska residents pay only around 5.4% each year. The four other states that follow Alaska are Tennessee (6.3%), New Hampshire (6.4%), Wyoming (6.6%), and Florida (6.7%).