It’s true — the wealthiest often pay the least in taxes.
ProPublica analyzed the IRS data on the tax information of the richest people in the U.S. and found that the true tax rate of these individuals was only around 3.4%. For example, Warren Buffett, one of the greatest value investors in the world, accumulated over $20 billion in asset value from 2014 to 2018, yet only reported around $125 million in income — and he only paid Uncle Sam $23.7 million.
You may be wondering, “How is this possible? It must be illegal!” Well, though Warren Buffett’s 0.1% true tax rate may seem unbelievably low, he didn’t break any laws. Instead, he took advantage of tax loopholes. Though you may not be able to shave millions off your tax bill, here’s what you can learn from the rich to reduce your tax burden this year.
Tax Tips You Can (and Should) Take From the Rich
1. Deduct Business Expenses
If you’re an entrepreneur or a small business owner, deducting your business expenses on your tax returns is a tax tip you should take from the wealthy. By claiming a deduction on legitimate and necessary expenses you’ve incurred for running a business, you lower your taxable income and reduce your tax liability.
For example, let’s say you sell beanies online. Here are some business expenses you can deduct:
- Materials: The cost of purchasing yarn, crochet hooks and other essential items to create your beanies.
- Shipping expenses: If you ship your beanies to your customers, you could deduct shipping supplies and any other fees charged by shipping companies.
- Home office expenses: Do you create your beanies and ship them from your home? If so, you could deduct a portion of your rent, mortgage, utilities and other expenses related to your home office.
- Marketing expenses: If you ran Facebook ads or paid influencers to promote your beanies, you could deduct the cost of these advertising expenses.
- Professional services fee: If you hired an accountant, graphic designer, social media manager, lawyer, marketing consultant or other professionals to help with your business, you could deduct their fees as well.
Be sure to keep receipts for all your business expenses and record all transactions in a bookkeeping system like QuickBooks. Doing so will save you a lot of hassle when it comes time to pay Uncle Sam. For more information on what’s considered business expenses, check out Publication 535 by the Internal Revenue Service.
2. Donate to Charities
It’s no secret that the ultrawealthy often uses philanthropy as a way to reduce their tax bill. If you want to support a worthy cause or help those in need — and also reduce your taxes like the rich — donate to charity.
However, it’s important to note that deductions to a charity are deductible only if you itemize. When you itemize deductions on your tax return, you can deduct charitable contributions up to 60% of your adjusted gross income. (See IRS Publication 526 for details.)
Also, the charity you donate to must have a 501(c)(3) status if you plan to deduct your donation from your tax return. Use this tax-exempt organization search tool to see if the charity is designated with a 501(c)(3) tax code and can receive tax-deductible donations.
3. Take Advantage of Tax Credits
Wealthy individuals are often masters of minimizing their tax liability. One crucial tax tip we could all learn from the rich is to make the most of our available tax breaks — such as tax credits.
Instead of lowering your taxable income, tax credits directly reduce the amount of tax you pay. In other words, it gives you a dollar-for-dollar reduction of your tax liability. So, if you’re eligible for a tax credit of $2,000, that means you’d pay $2,000 less in taxes.
Here is a list of tax credits you should know about:
- Child Tax Credit: If you have children under 17, you’re most likely eligible for the Child Tax Credit. As of 2023, the credit is up to $2,000 for each child. You can use this ITA tool to see if you qualify.
- Earned Income Tax Credit: The Earned Income Tax Credit helps low- to moderate-income families get a tax break. For the 2023 tax year, the maximum amount of credit you can receive ranges from $600 to $7,430 — depending on your situation. Use the EITC assistant to see if you qualify.
- Education Credits: If you’re a student, there are two education credits you may be eligible for: the American Opportunity Tax Credit and the Lifetime Learning Credit.
- Child and Dependent Care Credit. If you pay for child care or if you’re a caretaker of other qualifying dependents, you may be eligible for a child and dependent care credit to help cover your expenses.
4. Borrow Against Assets Instead of Selling
Borrowing against assets can be a powerful tool when it comes to maintaining wealth and protecting it from hefty taxes. Here’s how it works: Instead of selling your investments or properties and incurring capital gains taxes (up to 37% for short-term gain), you use your assets as collateral to obtain a loan.
For example, according to ProPublica, Elon Musk pledged a whopping 90 million Tesla stock shares, which were worth around $57 billion as of May 29, 2021, as collateral for personal loans. Instead of selling his Tesla holdings and incurring colossal capital gains taxes, Elon Musk lives tax-free and lavishly off his wealth by simply borrowing against his assets. Larry Ellison, Oracle’s chief executive officer, also pledged part of his company stock as collateral for a $10 billion personal line of credit in 2014.
Though you may not have billions in assets to borrow against like the ultra-wealthy, you can apply a similar strategy to your finances and lower your tax bill. For instance, instead of selling your home to pay for an emergency expense, use the equity you’ve accumulated in the property to secure affordable loans in the form of a home equity line of credit or home equity loan.
And if you use the funds to renovate your abode, you can deduct the interest on your HELOC or home equity loan to lower your tax bill. Plus, if the property is your primary residence, you can exclude up to $250,000 of capital gain from your income when you sell the home — up to $500,000 if you file a joint return.
5. Understand Step-Up Basis
The step-up basis is another key concept to understand if you want to lower your tax liability like the wealthy. Here’s how the step-up basis works:
Let’s assume you have a stock portfolio worth $300,000 that you purchased for $100,000 a couple of years ago. If you sold it today, you would have to pay taxes on the gain of $200,000.
However, if you leave this money to your heirs, the step-up basis allows them to inherit it at its current market value and resets their cost basis to $300,000. In other words, if your heirs decide to later sell the stock portfolio at $300,000, they wouldn’t owe any taxes at all.
This strategy is widely used by the rich to pass down wealth while minimizing tax liabilities.
But regardless of how much money you have, you can also take advantage of the step-up basis by assigning your assets to your beneficiaries upon death — creating generational wealth.
By doing so, your heirs can inherit your assets at their current market value and avoid capital gains taxes on the appreciation. So, be sure to keep this tax loophole in mind when planning your estate.
6. Cut Your Tax Bill With Tax-Loss Harvesting
According to Richard Lavina, Certified Public Accountant and Co-Founder of Taxfyle, tax-loss harvesting is a popular strategy that he sees many wealthy people use.
“Tax loss-harvesting involves selling investments that have lost value to offset capital gains from other investments — reducing your overall tax liability in a year that you anticipate more capital gains,” Lavina said.
Keep in mind that there may be specific tax rules and restrictions that apply to tax-loss harvesting, so make sure to speak with a financial advisor or tax professional to determine if this strategy is right for your situation.
7. Claim Depreciation
Wealthy people who own rental properties or businesses often deduct depreciation to lower their taxes. Depreciation refers to the decrease in value of an asset over time due to wear and tear, obsolescence or other factors.
The IRS allows you to claim depreciation as a deduction on your tax returns for qualifying assets used in your business or investment activities. For example, if you own a property that generates rental income, you could deduct a portion of the property’s cost over its useful life as depreciation — lowering your taxable income and reducing your tax bill.
Calculating depreciation can be complicated. If you plan on claiming depreciation on your tax return, be sure to consult with a tax professional.
8. Allocate Assets Wisely
Lavina mentioned that asset allocation is another strategy he’s seen many wealthy individuals use to minimize their tax liability.
“The rich often allocate their assets into tax-advantaged accounts such as IRAs, 401(k)s, and annuities, allowing them to defer taxes on investment growth until retirement, when they may be in a lower tax bracket,” Lavina said.
So, if you expect to be making less during your golden years, contributing to a traditional 401(k) or IRA can be a good strategy. By reducing your taxable income now, you can save on taxes in the immediate term and then pay less in taxes on the money you withdraw from your account in retirement — since you’d be in a lower tax bracket then.
On the other hand, if you expect to make more money in retirement, contributing to a Roth IRA might make more financial sense. You’ll pay taxes on the money you contribute now while you’re in a lower tax bracket, and when you withdraw the money in retirement, you won’t owe any taxes.
Learn To Play The Game Like the Rich
You know what they say — “don’t hate the player; hate the game.” The U.S. tax code is complex and has dozens of provisions that allow the nation’s top earners to legally sidestep income tax even as their bank accounts keep ballooning. Though this might sound unfair, the truth is that the tax game is open to anyone who wants to learn its intricacies and play it well.
So, instead of sitting on the sidelines, take the time to understand these loopholes and tailor your financial strategies accordingly so you can also protect your wealth during tax season.
Jamela Adam is a personal finance writer covering topics such as savings, investing, mortgages, student loans, and more. Her work has appeared in Forbes Advisor, Chime, U.S. News & World Report, RateGenius and GOBankingRates, among other publications.