How Thousands of Wealthy People Pay No Taxes (It's Totally Legal)
With the rise of the Occupy Wall Street movement and its focus on the 1%, the wealthiest people in the U.S. have gotten a lot of attention lately. Yet despite arguments back and forth about whether the rich pay their fair share, one thing is certain: Some high-income earners pay no taxes at all.
A recent IRS study found that one in every 189 taxpayers earning $200,000 or more in adjusted gross income paid no income tax in 2009, the most recent year for which complete data is available. That's more than 10,000 wealthy households paying no taxes anywhere in the world, and more than 35,000 paying no U.S. income tax.
How Did They Swing That?
There are several popular methods high-income taxpayers employ to cut their taxes. The most widely used is to invest in tax-exempt municipal bonds, which pay interest that you don't have to include as taxable income on your tax return.
But itemized deductions also play a key role in reducing tax liability for the rich. Although medical and dental expenses aren't deductible until you spend at least 7.5% of your income on them, some rich taxpayers can use expenses they'd have to pay anyway to offset all of their income. Similarly, deductions for state income and property taxes, as well as charitable contributions, also help rich taxpayers reduce their tax burden.
Idle Threats
The fact that the rich can pay little or no tax under current law has led to proposals to change those laws.
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Many celebrities have gotten smacked down for failing to paying taxes. Wesley Snipes actually landed in prison for his $17 million unpaid tax bill, while Nicolas Cage owed a seven-figure amount to the IRS. A host of others, including Lindsay Lohan, Pamela Anderson, and Christina Ricci, have faced liens or tax bills for more modest -- yet still sizable -- sums.<br />
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The two main reasons for us ordinary folks getting stuck with a big tax bill are that your paycheck withholding needs changing or that you have outside income that comes without having taxes withheld. In either case, even if you can't afford to pay when the bill comes due, ignoring the problem will eventually land you in an even bigger heap of trouble. Instead, take advantage of IRS programs that let you make affordable installment payments over time.</p>
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Part of what put Wesley Snipes behind bars was his conviction on three counts of failing to file tax returns by their filing date. In part, he relied on a bogus theory that all income taxes are unconstitutional as justification for his actions.<br />
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But a much more common problem many people run into is that they can't afford to pay their tax bill right away. The mistake they often make is to assume that they shouldn't file a return at all if they can't pay. In reality, the penalties for not <em>filing </em>your taxes are much more severe than if you file but can't pay<em> </em>your taxes all at once. So even if you don't have the money to send with your return, go ahead and file. It'll save you a ton of money -- and possibly jail time -- in the long run.</p>
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AccountingWEB recently took a look at some of the great swag that celebrities received at the Academy Awards. With sponsors handing out goodies including everything from jewelry to exotic safaris, the gift packages added up to as much as $75,000 in value. But the recipients have to report it all as taxable income.<br />
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You may never be so lucky, but even more modest prizes often get reported to the IRS. If you get a Form 1099 reporting the value of something you received as a prize or award, not<em> </em>including it on your tax form could trigger a red flag at the IRS.</p>
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One allegation that Nicolas Cage raised regarding his tax problems was that his business manager mishandled his funds and caused big losses that destroyed his finances. Similarly, Martin Scorsese and Al Pacino both blamed convicted adviser Kenneth Starr for their tax woes. Starr went to prison for fraud and theft from clients.<br />
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Still, no matter where you go or how much you spend for tax preparation, <u>you</u><em> </em>bear final responsibility for making sure your tax returns are accurate. Reputable accountants will reimburse you for any penalties and interest that result from mistakes they make, but don't count on them. Instead, make sure you understand the positions your tax pro takes so that you can defend them if a question arises.</p>
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As you look at the hijinks of your favorite celebrities, be sure not to make the same tax mistakes they made. With a little common sense and some planning, you can learn from celebrity mishaps the easy way.</p>
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Between the so-called "Buffett Rule," which would impose minimum tax rates on high-income taxpayers, and calls to limit the tax benefits from certain popular deductions, the rich soon may no longer be able to escape paying tax entirely.
But in an election year, it's hard to envision such measures getting through Congress to become law -- and unless they at some point do, the rich will still have perfectly legal ways to protect their income from the IRS.
For more on your taxes:
You can follow Motley Fool contributor Dan Caplinger on Twitter here.
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