Bigwig CEOs don’t pay taxes, why should you?

How the pros get away with not paying taxes, and how you can too.

It’s time to party like a Rockstar. Only “partying” is paying taxes and the “Rockstars” are corporate CEOs. The irony of such a line is that Rockstars actually pay exorbitantly high taxes while the quiet billionaires signing their checks seem like they skip the Taxman all together. How can this be? Better yet: How can I skip the Taxman like they do?

First off, I’d like to point something out. CEOs do in fact, know how to skip out on taxes. Remember when Warren Buffet, the 3rd richest man in world gave that passionate speech about this very topic? The Sunday Times reported that he called out lawmakers at a fundraiser saying that he paid only 17.7% in taxes while his secretary paid 30%. Buffet was making a political statement about tax reform but why should we wait until reform when we could start not paying taxes today?

How they do it:
The key to rich people’s tax success is defining their income. For example, if you or I make a buck its called a salary or wage and its taxed in the appropriate “marginal” tax bracket. When they make a buck, its usually not in wages but a return on some investment they had. Their accountants call it “capital gains” and they only pay 15% on it regardless of how much they make otherwise. Now that might actually be fair considering they had to risk that money and our wages aren’t much of a risk and with risk, comes reward. To see a neat graph on this, check out this blog. It shows the how taxes of the 400 richest Americans are tied not to income tax but capital gains tax.


How we can do it:
Don’t worry, I’m not going to suggest that you forego all you income and invest it all in risky investment simply to lower your tax bill. But there is a principal that we can start applying today that will reduce our taxes guaranteed. Here’s the trick: instead of looking at which tax bracket you fall into on a year-to-year basis, try stepping back and consider the total amount you pay in taxes compared to total net-worth.

Rockstars pay such high taxes because they spend every dime they get. Need proof? Google: “Wesley Snipes IRS”. The pros know that the IRS builds tax breaks into the system for people who don’t spend their money. These are called IRA’s (see IRA section below). Remember that a Roth IRA is taxed now and never again, even if you get a million dollars in there. That means you’ll still be paying 20-30% of your wages in taxes, but you Roth IRA gains will be taxed at 0%. The higher the value of your Roth IRA account, the lower your effective (real) tax rate becomes.

Let’s play it out with the Smith family. They earn $70,000/year. Their first $17,000 is taxed at 10%. Everything from there up to 69,000 is taxed at 15% and that last bit is taxed at 25% (note: these do not includes state taxes). Their total effective (real) tax rate is about 14%. Not bad, but we can do better.

If the Smith’s socked away 10% of their income every year into a Roth IRA, after 10 years they would have $120,000 set aside that would never be taxed (assuming 10% growth/yr). Great news for the Smith’s but the better news would be that that all by itself that nest egg would make another $12,000/year. So the Smith’s would still be paying an effective (real) tax rate of 14% on their wages of $70,000 but the extra $12,000 isn’t taxed! That brings their actual tax rate down to about 11.9%. We just legally lowered their tax bill! It’s good to have control over taxes. Let’s keep going. What if they keep investing and really save up their nest egg? We’ll check in on them 30 years down the road. Saving 10% of their income they now have about $1.5M in tax free savings. If they still earn $70,000 that year, their savings will also earn them another $150,000 for a yearly total earnings of $220,000. Best of all, they’ll only pay taxes on their wages of $70k. They’ve just lowered their effective (real) tax rate to a measly 4.45%.

Congratulations, Smiths. You’re now partying (paying taxes) like a Rockstar (CEO).