Trump may keep his TCJA from expiring this year as Biden, seeking wealth taxes, claims: “No billionaire should pay a lower tax rate than a teacher, a sanitation worker, a nurse.” The IRS and SEC monitor salaries, securities sales, dividends and large estates, so petty tax cheating distracts few rich people and jail awaits sophisticated shenanigans. How could the rich pay lower rates?
The Federal Reserve reports that the top 1% now holds 23.3% of the nation’s wealth, or nearly three times as much as the 8.1% held by the middle classes. California’s 1% earned AGI of $1,024,599 and their wealth exceeds $13.6 million. They pay top levels of federal (37%), Social Security (12.4% to $169K), Medicare (2.9%) and state income taxes (12.3%), a 1% Mental Health Services Tax. Do shelters save them?
The Alternative Minimum Tax, from the 1960s, recalculates returns with good deductions (e.g. ISOs) so all pay at least 28%. Married middle class taxpayers are spared by a $133K exception. Trump’s 2017 taxes helped the rich avoid AMT with more exemptions and fewer deductions for state and local tax and miscellaneous expenses (union dues and investment advice).
Forty years later, President Obama wanted the rich to pay for healthcare, so he added two taxes for couples earning more than $250K: a 0.9% Medicare surcharge tax on earnings and a 3.8% tax on investment income, like capital gains, dividends, rents, etc.
Individuals and businesses are taxed when they earn profits and losses are fairly carried forward to cut taxes in years of profit. Startups and businesses that survive crises give useful payments and employment. Depreciation deductions in business and real estate do encourage investments in equipment and land, which make employment and housing possible. Wealthy entrepreneurs merely defer taxation with Defined Benefit Plans or Annuities. Income shifting merely appears abusive.
But most tax shelters for the rich generate long-term capital gains taxed outside CA at 20% rates. Highflyers in high tech get ISOs as incentives; if they sell more than two years from grant and a year from exercise, then gains are taxed favorably. General Partners of investment firms earn both management fees tied to management assets and “carried interest” related to percentages of profits generated by assets. The IRS has encouraged investment by exempting income from payroll taxes and granting capital gains rates to managers who gambled on the economic miracle of this valley.
When wealthy couples, using marital deductions, envision their inevitable demise with 2025 estates over $28 million, they face estate taxes of 40% of accumulated wealth with gift and generation skipping transfer taxes imposed to split estates and limit tax evasion. Kiddie taxes and trust taxes prevent income shifting, but Family Limited Partnerships may preserve family wealth. The IRS taxes personal gifts to evade estate taxes and GSTT taxes, so trust giving in dynasties won’t evade taxation.
Some will shed wealth by giving directly to others’ medical or educational needs, while others increase charity. Indecisive givers will contribute to Donor Advised Funds to get immediate tax deductions with later contributions. The wealthy may even establish irrevocable charitable remainder trusts, which let them take charitable deductions now with money that partially returns to them through annuities or trust percentages before the remainder passes to charity. Fees and restrictions discourage a deal that would please a greedy Scrooge. Private foundations let the wealthy donate and then pay themselves to care for assets.
Daniel Hemel, tax law professor, estimates that: “The richest Americans are able to pass down approximately $200 billion each year without paying estate tax on it, thanks to the use of complex trusts and other avoidance” (NY Times, Dec. 7, 2024). The rich can employ lawyers for Intentionally Defective Grantor Trusts or insurance agents for Irrevocable Life Insurance Trusts to reduce estates.
The Dynasty Trust, long term and irrevocable, protects assets from creditors and tax collectors as it seeds wealth to multiple generations for 90 years in California. Grantor gifts ultimately pay distant relatives, sometimes controlling behavior. Lawyer loopholes do cut taxes. But Yahoo Finance says, “Ultra-wealthy Californians, the top 1%, typically pay between 40-50% of the state’s personal income tax revenue. And some have clearly had enough of propping up the state’s finances.”
Robert Arne, EA, CFP, MS, of Carpe Diem Financial Life Planning, gives holistic financial advice as his client’s fee-only fiduciary. He serves mostly Santa Cruz Mountain dwellers. These articles must not be read as personal financial, mortgage, tax or investment advice; consult appropriate professionals. Learn more at www.carpediem.financial.
