Last week, ProPublica dropped a billionaire bombshell revealing that America’s ultra-wealthy have a true federal income tax rate of only 3.4%. The investigative journalism nonprofit obtained leaked Internal Revenue Service (IRS) tax documents revealing the financial lives of tycoons including Warren Buffet, Elon Musk, Jeff Bezos, and Mark Zuckerberg. An unknown entity leaked the tax returns of thousands of the country’s wealthiest residents to ProPublica. The tax documents span fifteen years and offer an unprecedented glimpse into the income, investments, and taxes of the billionaire class. The findings from these leaked documents are truly shocking.
In 2007 and 2011, the world’s richest man, Jeff Bezos, did not pay a single penny of federal income tax. Other billionaires have achieved this same feat, including Elon Musk, George Soros, and former presidential hopeful, Michael Bloomberg. Under the current American tax system, the rich pay only a fraction of the millions (or billions) their fortunes increase–and it’s totally legal.
The highest federal income tax bracket went into effect earlier this year. Essentially, the tax rate for a couple making over $628,300 in combined annual income is 37%. However, America’s wealthy elite have managed to elude this IRS tax rate, with the wealthiest 25 people paying a combined true tax rate of just 3.4%.
The average American household income is $70,000 per year, and these families pay approximately 14% in federal income tax. However, in 2011, Jeff Bezos’ wealth was a staggering $18 billion. But on his tax return he claimed he actually lost money and received a $4,000 tax credit for his children.
The average American has income generated from working a job. Billionaires, on the other hand, amass their fortunes from assets, like stocks or property when they appreciate. Under current U.S. tax laws, this wealth only counts as taxable income when these assets are sold. ProPublica compared the tax records of America’s billionaires to their estimated wealth with information obtained from the 2021 World’s Billionaire List (Forbes). According to Forbes, the 25 wealthiest people saw a collective wealth increase of $401 billion in a span of only four years while paying a combined total of just $13.6 billion in income tax. While $13.6 billion may seem like an unfathomable amount of money, it equates to a mere true tax rate of 3.4%. If you compare this small rate to the 14% tax rate the average American household pays, these numbers are truly jarring (not to mention unfair and infuriating).
Billionaire Warren Buffet is a well-known advocate for higher taxes on the rich. Despite his public stance on wealth tax, the Oracle from Omaha has infamously boasted that he pays less in federal income tax than his secretary, according to Entrepreneur (Wheelwright, 2019).
From 2014 to 2018, Buffet increased his wealth by $24.3 billion and paid only $23.7 million in taxes, for a true tax rate of 0.1%. To put this into perspective, that tax rate boils down to Buffet paying just 10 cents on every $100 his wealth grows. That tax rate is, essentially, equivalent to a sales tax rate in some states.
So, how are the ultra-wealthy able to pay less in federal income tax than the average American family? To answer this question, let’s examine why wealth and income are not mutually exclusive in the eyes of the federal government.
The tax avoidance techniques of the ultra-wealthy are perfectly legal. Unlike the average worker, billionaires do not require a salary to get by financially. In fact, ProPublica reported that Bezos’ Amazon salary is a modest $80,000 per year. The reason Bezos and other billionaire CEOs opt for low salaries is because this income is taxed at a higher rate than their assets. In fact, the 25 richest Americans only reported $158 million in wages for the 2018 tax year, which equates to a mere 1% of the income reported on their tax forms. The rest of their wealth consisted of dividends, stock sales, and other investments, and these income sources are taxed at a much lower rate than workers’ wages.
According to UC Berkeley economists, Emmanuel Saez and Gabriel Zucman, American billionaires hold $4.25 trillion in wealth. And $2.7 trillion of that wealth is deemed “unrealized” (Saez & Zucman, 2021). Unrealized gains refer to the shares in companies that billionaire founders typically retain, which fluctuate in value according to stock market conditions. Berkshire Hathaway founder, Warren Buffet, has avoided transforming his wealth into income by holding on to his company’s stock. Buffet has an estimated net worth of $110 billion, but from the years 2015 to 2018, he only reported annual income amounts ranging from $11.6 million to $25 million.
To put this wealth-income disparity into context, Warren Buffet is the sixth-richest person in the world, yet there were 14,000 taxpayers in 2015 who reported earning a higher income than him. His strategy is two-fold. His company does not pay quarterly dividends to stock owners and instead invests dividends back into the company to grow stockholders’ shares. This strategy is incredibly effective. Otherwise, Buffet would receive more than one billion dollars in dividend income, on which he would owe hundreds of millions in income tax each year.
Despite modest salaries and unrealized wealth tied up in company stocks, billionaires can sidestep federal income taxes and fund rather lavish lifestyles. The strategy they use to afford this way of life isn’t perplexing: they borrow money. Billionaire borrowers use this technique to access large amounts of income without paying taxes on it. The Internal Revenue Service does not view loans as income. And shockingly low interest rates, thanks to massive amounts of collateral, make this option very appealing for many of America’s wealthy who wish to avoid high income tax rates or selling stocks and losing control of their companies. Using this strategy, wealthy tycoon, Elon Musk, was able to pay a mere $68,000 in income tax in 2015 and $65,000 in 2017.
Regular taxation of income and wealth is not mentioned in America’s founding documents. This is, after all, the country of the Boston Tea Party rebellion. In the country’s infancy, the American government primarily funded its operations through indirect taxes like tariffs and levies for consumer goods like tobacco and alcohol, much like modern-day sin taxes. In 1861, the staggering costs of the American Civil War prompted Congress to enact a federal income tax to pay for the aftermath of the conflict but pressure from wealthy citizens soon led to the law’s repeal.
Continuing America’s long-standing taxation conundrum, the federal government had to reconsider federal income tax initiatives. The Industrial Revolution prompted a need for government agencies focused on food security and workers’ rights. Despite the growing need for funding, in 1894, the Supreme Court rejected another push for federal income taxation. Thus, Congress needed to amend the Constitution and, in 1913, granted the federal government the ability to collect taxes from income sources. This initial federal income tax system worked very differently than that of today’s laws. In 1918, only 15% of American families paid any amount of income tax. The legal parameters for what income “sources” qualified as legally taxable led to a contentious Supreme Court debate which set the stage for modern tax-avoidance techniques.
The Supreme Court Case, Eisner v. Macomber, laid the groundwork for the modern tax system. The court determined that an individual needed to sell an asset – such as a stock, bond, or property – for said asset to count as taxable income (Clark, 1920). There were many early opponents to this ruling, as some tax scholars feared the law would allow the mega-rich to live off the wealth of their holdings without paying taxes on their astronomical fortunes. Indeed, this ruling created the most glaring loophole in the American tax code, which allows the wealthy to borrow money against their stock values to pay living expenses. Essentially, this system creates a low-risk safety net for the wealthiest Americans’ incomes as they can use their collateral to procure low-interest loans and live off these loans. In fact, they can even claim the interest from the loans on their tax documents to get generous tax breaks.
Ever-evolving tax concerns have been a key platform for the past several presidents. From aggressive taxation proposals under Franklin D. Roosevelt and Lyndon B. Johnson to the corporate-friendly approach of Ronald Reagan, the debate over America’s income tax inequalities is far from over. The Biden administration has proposed raising tax rates on individuals making over $400,000 from 37% to 39.6%, with a similar tax rate on long-term capital gains. To better fund the IRS’ initiatives, the administration wants to boost the corporate tax rate as well. There have even been proposals from Senators like Oregon’s Ron Wyden to begin taxing unrealized capital gains.
One thing is certain, the Biden administration plans to be tough on tax evasion. Afterall, this new administration has already proposed an $80 billion revenue increase to support the initiatives of the Internal Revenue Service. In light of the recent IRS leak of the wealthiest American’s tax records, there will likely be much political backlash and public pressure for a true examination and proposed overhaul of the current federal income tax structure.
Federal income tax laws are ever evolving and difficult to understand, which is precisely why Vic Abajian founded Abajian Law in 2006. As a former IRS tax attorney, Mr. Abajian has the expertise individual and corporate clients need to navigate complex tax issues. Abajian Law has a proven track record of successfully advocating for individuals and businesses to resolve multi-faceted legal concerns, such as tax litigation, foreign bank accounts and FBAR penalties, tax fraud, and trust fund recovery penalties (TFRP).
Vic leverages his experience as a Senior Trial Attorney with the IRS Office of Chief Counsel to advocate for his clients on a wide array of tax-related legal issues. During his time as an IRS trial attorney, Mr. Abajian was recognized by the Department of Treasury for his outstanding service. Vic brings the same reliable, professional, and experienced approach to his Los Angeles Tax Law Firm. Vic has helped countless individuals and companies successfully advocate their cases before the IRS.
If you are an individual or company facing tax issues, Abajian Law is standing by to assist you with the daunting task of going before the IRS. Our expert legal team has helped countless clients successfully resolve their tax cases. Serving Glendale, Pasadena, Irvine, and Los Angeles, our team is ready to answer your questions and guide you through this difficult process.
Do not go up against the IRS alone. Contact the Los Angeles, California, tax attorneys at Abajian Law today at 213-943-1316.