At tax time, middle-class Americans look to maximize their refunds, minimize their bills and claim all possible credits and deductions. It’s a yearly chore they want to hustle through so they can get on with their lives until it’s time to do it all over again next year.
But for the rich, tax planning joins income and investing as the three primary means of preserving and building wealth. From their philanthropic donations to the trusts they use to hand down their assets, comprehensive tax planning is a central pillar of wealth retention for America’s most affluent households.
For average earners in the middle class, W2s, 1099s and bank and brokerage interest documents start arriving in January. Then they gather and organize them until it’s time to file their returns sometime before April 15.
But for the rich, tax planning is a part of daily life that’s at the forefront of most financial decisions 365 days a year.
“High-net-worth individuals (HNWIs) manage their finances with a distinct focus on tax planning, differing significantly from the middle-class approach of just considering tax implications when they have to file their annual tax forms,” said Johan Garcia, a CPA with a master’s degree in tax and more than 10 years of experience in tax advisory, tax compliance and business advisory. “HNWIs estimate their annual tax liability quarterly, projecting taxable income from various sources and adjusting forecasts based on actuals as the year progresses.”
By considering tax implications all year long, Garcia said, the rich get an accurate and evolving understanding of their tax obligations, which supports informed decision-making regarding taxable activity.
“For example, the sale of investment assets, charitable donations or adjusting investment strategies,” said Garcia, who previously served as the lead tax strategist for a publicly traded Fortune 500 company and is currently the owner of After Tax Cash and principal of JG CPA & Advisory. “Here’s an example that I was just dealing with today for an HNWI taxpayer who travels constantly to New York for business purposes: We have to track the days spent in New York because more than X number of days could make him a part-time resident of the state and subject his overall taxable income to New York State income taxes.”
Middle-class Americans usually self-file with software like TurboTax or enlist the help of a neighborhood CPA or accountant from a national chain such as Jackson Hewitt.
“Most middle-class people decide to handle filing their taxes themselves; and, unless they are tax professionals, they stand to miss out,” said Miles Brooks, CPA, director of tax strategy at CoinLedger.
The rich, on the other hand, have teams of specialists on retainer or even working for them exclusively in family offices.
“In my experience, the rich are very invested in tax planning,” Brooks said. “Since they can afford financial and tax experts, they have legal structures and financial tools to maximize their deductions and minimize their tax burdens.”
Their teams might include wealth managers, tax attorneys, accountants, philanthropy specialists and investment advisors, all of whom are involved in their wealthy clients’ financial lives — not just in the run-up to tax season but all year round.
In 2019, CNBC examined how the super-rich manage to pay lower taxes. One strategy was to increase their equity exposure since long-term capital gains taxes are typically lower than the income tax rate and to manage and spread out their gains.
That’s just one tactic. The wealthy make nearly all investments with the IRS in mind.
“The rich are strategic in their investments, which influences their taxes, a factor most middle-class people don’t consider when jumping to invest,” Brooks said. “Most wealthy people get their income from investments, and most choose capital gains because they are taxed at a rate lower than ordinary income. They also take advantage of deferring capital gains when holding investments for the long term.”
Most middle-class Americans, on the other hand, contribute to their retirement funds and brokerage accounts based solely on their investment strategies or 401(k) plans and calculate their tax obligations when they receive their 1099-Bs and fill out their Schedule Ds during tax season.
For the middle class, the IRS determines their tax-related timing. The agency starts accepting returns sometime in late January — Jan. 29 this year — and sets the deadline for filing on or around April 15.
But the rich are one step ahead of the Treasury Department. They buy, sell and trade assets to their advantage well in advance of tax season.
“Timing is everything, even in taxes,” Brooks said. “Rich people have a flexible timing of their income. They delay capital gains and bonuses to lower their tax liability for some years, and they delay deductible expenses.”
But you don’t have to be rich to play the game. For example, even middle-class investors can engage in tax-loss harvesting, the intentional selling of investments at a loss at year’s end to offset capital gains.
Most Americans figure out which credits they’re owed and which deductions they can claim as they plug their information into their tax software of choice.
The wealthy are much more proactive.
“Most rich people take deductions and credits very seriously,” Brooks said. “They use provisions like real estate depreciation, charitable donations and business expenses to reduce their taxable income.”
Their teams of specialists strategize to maximize credits and deductions throughout the year and, according to Brooks, most incorporate estate planning to gift assets and establish trusts to pass wealth and reduce tax implications even further.
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