I’m a Millionaire: Here’s What I Pay in Taxes
Written by
Aja McClanahan
Edited by
Travis Woods
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Achieving millionaire status is a milestone many aspire to but as someone once said, “more money, more problems!” By problems, we mean tax liabilities!
The good news is that the U.S. tax code contains several provisions that can reduce taxes for high-net-worth individuals. We’ll explain how much high-net-worth individuals, such as millionaires, pay for taxes and discuss strategies they may use to reduce their tax liabilities.
How much does the average millionaire pay in taxes?
The amount of taxes paid by millionaires varies widely based on many factors, including their exact level of millionaire status, income sources, state of residence and the extent to which they utilize tax optimization strategies.
The White House analyzed and summarized what the wealthiest Americans pay for taxes in 2021, “we estimate that the 400 wealthiest families paid an average Federal individual income tax rate of 8.2% on $1.8 trillion of income over the period 2010-2018, the years from the last decade for which the necessary data are available.”
Though each person’s financial situation is different, here are a few ways millionaires end up paying less in taxes.
Maximizing retirement account contributions
One way high-earners can reduce their tax liability is by contributing the maximum allowable amount to retirement accounts such as 401(k)s, IRAs and SEP IRAs, all of which can significantly reduce taxable income. For business owners making contributions to their solo 401(k) accounts, annual contributions can be up to 3 times higher depending on their circumstances. Using any combination of these tax-advantaged retirement accounts can greatly reduce your amount of taxable income, a key factor in calculating tax liability.
Using other tax-advantaged accounts
Health Savings Accounts (HSAs), Flexible Spending Accounts (FSAs) and Education Savings Plans, commonly known as 529 Plans, are all different accounts that offer benefits like tax-deductible contributions, tax-free (or reduced tax) growth, no taxes on qualified withdrawals and, in some cases, state tax deductions or credits, depending on the state of residency.
The rules vary for contribution limits, withdrawals and tax-preferred treatment based on the account in question, but many high-net-worth individuals use these types of accounts to reduce their tax liabilities. You should work with a financial professional to add this strategy to your financial planning as needed.
Investing in tax-efficient investments
Investing in municipal bonds can be an effective strategy for millionaires to reduce their tax liabilities because these bonds often yield interest that is exempt from federal income taxes and sometimes even state and local taxes, depending on where you live. Index funds and ETFs also offer tax efficiency since they tend to have lower turnover rates than actively managed funds, leading to fewer taxable events that trigger tax liabilities. Capital gains management through strategies like tax-loss harvesting allows investors to offset capital gains with losses and typically reduce taxable income.
Be a dividend millionaire
Focusing on stocks that pay qualified dividends can reduce tax liabilities because qualified dividends are taxed at a lower capital gains rate rather than the higher ordinary income tax rate. The White House report mentioned above notes that confirm wealthy individuals have income “that is taxed at preferred rates. In particular, income from dividends and from stock sales is taxed at a maximum of 20% (23.8% including the net investment income tax), which is much lower than the maximum 37% ordinary rate that applies to other income.”
Take advantage of tax deductions and credits
Tax deductions and credits can also reduce the taxable income for millionaires, lowering their overall tax liability.
Morris Armstrong is the founder of Armstrong Financial Strategies, a registered advisor firm located in Cheshire, CT. His practice advises many millionaires to be high-net-worth individuals.
He says, “Millionaires over age 70.5 who are taking distributions from an IRA can save on taxes by using a Qualified Charitable Distribution – having the IRS custodian cut a check to the charity. ” He explains further, “This allows the taxpayer to have the amount count towards the required minimum distributions (RMD) but is not included in the adjusted gross income (AGI)calculation. This can be a lifesaver since it impacts AGI, which is a determining factor in the Medicare premiums that you will pay and in calculating your state exclusion.”
Other tax deductions include the mortgage interest deduction for primary or secondary residences and tax credits for energy-efficient home improvements.
Using business-related strategies
There are also a number of business-related tax strategies that can reduce your tax liabilities as a millionaire. By structuring your businesses as pass-through entities like LLCs or S-Corps, you can take advantage of the Qualified Business Income (QBI) deduction, deducting up to 20% of your qualified business income, thereby reducing your taxable income. Additionally, owning real estate or equipment through businesses allows you to depreciate and expense deductions, also lowering taxable earnings.
Tax planning and professional advice
If you are a millionaire or will soon be, engaging in annual tax planning helps you strategically pay less taxes by anticipating changes in your unique financial situation and applicable tax laws. Working with tax advisors and financial planners ensures you leverage all possible deductions, credits, and investment strategies for the best tax outcomes.
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