How to Pay No Taxes – Strategies Used by the 1%

July 29, 2013

A very expensive yacht.

You might not have the kind of money that the rich (and perhaps famous) have, but there are some strategies that they employ on a regular basis to avoid paying taxes, and maybe you can use some of them yourself.

  1. Get cash for your stocks without selling them

OK, so you have a million dollars in stocks, and you don’t want to sell and pay the capital gains taxes that you would incur. But you need cash. So what you do is, you take a loan out from an investment bank, using the stock as collateral. To make sure your stock retains value, you buy options to balance out any share price change.

That’s it. You’ve secured yourself a huge cash infusion, while incurring zero tax liability. Depending on the terms of the loan, you may never have to pay the cash back. Or, when you finally do, you can simply hand over the shares and pay the tax bill, but in the meantime you have basically been able to “have your cake and eat it, too.”

The IRS has recently challenged some high-profile uses of this strategy and won, but apparently that has not dampened enthusiasm for this type of tax avoidance method.

  1. Leave money to your heirs with no estate tax

If you have a substantial estate that will trigger estate taxes when you die, there are ways to still leave money tax-free to your heirs. One popular method is to put a substantial amount of money into a GRAT, a Grantor Retained Annuity Trust.

In this situation, a large amount of money is put into the trust, but the money, plus interest, must be returned to the parent within a specified amount of time. When that time is due, the money and interest (currently the IRS requires 3%) must be returned to the parent’s account. However, any excess value that the trust has earned can be retained in the trust, and left tax-free to the heirs when the parent dies.

  1. Sell investment real estate without incurring taxes

This is another tax-deferred kind of deal, like the loan situation in example #1. An investor has an investment property that has been full depreciated, so its sale would be a taxable event. Instead, the investor forms a partnership with the person who wants to buy the property.

The investor contributes the property to the partnership, and the partner contributes cash or other property. The partnership then takes out a loan using the property as collateral, and distributes the cash to the investor who wanted to sell, and no taxes are owed, because the property was not actually sold.

  1. Take out a life insurance policy

An important part of estate planning for any high net worth people is the life insurance component, and most financial planners are well acquainted with a variety of options.

While most regular people are encouraged to buy term life insurance and avoid the high commissions and fees associated with investment-related life insurance policies, there are many advantages to such vehicles for very wealthy people.

The death benefit, and any returns that the policy generates, are all transferred to heirs free from income taxes. Estate taxes can also be avoided if the policy is held in a particular type of trust.

For the top 1% of taxpayers, effective tax rates tend to be lower than for taxpayers in the next tier down, according to the IRS. Because of tax avoidance and tax deferral strategies that are commonly used by very high net worth individuals, these people can often finance their lavish lifestyles by using lines of credit and loans taken out against the value of their properties; these loans often have extremely generous repayment terms, and allow people to live extravagantly without having to pay income tax on the cash.

Unfortunately, these sorts of schemes are the exact type of thing that enrages the average person, who feels that the deck is clearly stacked against the less wealthy.

And that regular person? Is not wrong. There is clearly something very skewed about the current United States tax system, and hopefully all the calls for reform will bring about something in the future that will be more fair to everyone.