Tesla chief Elon Musk recently claimed while campaigning for President-elect Donald Trump that he is the largest individual taxpayer in history. Musk claimed he paid over $10 billion in taxes to the Internal Service Revenue (IRS). Jokingly, the billionaire said he wished the IRS would send him a trophy, even a small, inexpensive one that kids win in karate competitions. While sighing that he didn't receive anything, he clarified that he was happy to pay taxes for society overall.
However, ProPublica's analysis of IRS data from 2014 to 2018 revealed that Musk paid no federal income taxes in 2018. More surprisingly, Michael Bloomberg was able to pay taxes at one of the lowest rates by claiming deductions of over $1 billion. Between 2013 and 2017, Bloomberg deducted an average of $409 million annually from his state and local tax liabilities. Even billionaire investors like Carl Icahn and George Soros avoided paying taxes for multiple years in a row despite tremendous net worth growth during the same duration.
Higher Income Doesn't Always Mean Higher Taxes for the Super-Rich
A couple of years ago, ProPublica conducted an internal analysis of the 25 wealthiest Americans' net growth compared to how much they paid in taxes between 2014 and 2018. The research revealed that their collective wealth increased by $401 billion during that time but only paid $13.6 billion in federal income taxes in those five years, translating to a true tax rate of just 3.4%. Although you are supposed to pay higher taxes in America as your income grows, high-net-worth individuals (HNIs) often leverage strategies to save taxes that are out of reach for common people. This way, they can reduce their tax rates significantly. The rich typically derive their wealth from the value appreciation of assets such as stocks or real estate. It is important to note that stock capital gains and real estate value appreciation aren't taxable unless sold. In stark contrast, ProPublica found that middle-class American households with wage earners in their 40s witnessed post-tax net worth growth by an average of $65,000 between 2014 and 2018, primarily due to home value appreciation. Furthermore, they paid an average of $62,000 in taxes in the same duration, given that most of their earnings were salaries from their jobs.
Although HNIs like Musk claim to pay billions of dollars in taxes, they can reduce their tax liabilities since most of their net worth is tied to assets they own. From 2014 to 2018, Musk's wealth grew by $13.9 billion, but his total reported income was only $1.5 billion, which led him to pay taxes of over $450 million at a true tax rate of 3.27%. Meanwhile, Warren Buffett's net worth increased by $24.3 billion over the same period, but his reported income was only $125 million. Overall, the Berkshire Hathaway chair paid only $23.7 million in taxes at a true tax rate of 0.10%.
The Most Popular Strategy Hnis Use To Avoid Taxes on Retirement Savings
The US Treasury estimates that over $150 billion in taxes owed by the top 1% goes unpaid annually. They can achieve such monumental tax savings by leveraging several strategies, including tax-advantaged retirement plans. Traditional 401(k) accounts are among the most popular retirement investment vehicles in the US that grow your pre-tax money from your paycheck completely tax-free, which you can withdraw penalty-free when you turn 59 ½. Those without access to 401(k)s often opt for individual retirement accounts (IRA), which offer similar benefits to a 401(k) but have a lower annual contribution limit of $7,000 for 2024. While many choose IRAs, given the wide range of investment options and annual tax benefits as their pre-tax contributions grow over time, account holders pay taxes on withdrawals in retirement since it is treated as regular income.
Wealthy people like PayPal founder Peter Thiel create backdoor Roth IRA accounts to avoid paying taxes on retirement withdrawals. Thiel is known for growing his $1,700 Roth IRA account to $5 billion over the years, and he won't pay any taxes when he withdraws from that account. Roth IRAs accept post-tax contributions and ensure that your withdrawals later in life are tax-free. However, only individuals with modified adjusted gross income (MAGI) under $161,000 in 2024 are eligible to create and contribute to a Roth IRA account. HNIs often bypass this income limit by making a backdoor Roth IRA, which entails converting your traditional IRA into a Roth IRA. In the process, they pay taxes on their pre-tax contributions to their traditional IRA and any capital gains only once. Once the funds are rolled over to a Roth IRA after paying appropriate taxes, account holders never pay taxes on any withdrawals.
