Have you ever wondered why the rich are getting richer? Or how they’re able to pay very little in taxes compared to how much they make?
Sure, they use some tricks that you already know about such as writing off all of their expenses like their cell phone bills or claiming part of their home as office use…but none of those small tricks really save them that much money.
The way the rich are actually growing their wealth is through a handful of tax saving shelters…which I’ll describe below in a bit. Now, many of these methods may seem illegal, but if you happen to ask a lawyer, I bet they’ll say that they are 100% legal.
Here’s why the rich are getting richer:
Captive Insurance company
Insurance is something you already have. But did you know that you could own your own insurance company? Any business that has a risk of losing money can be classified as an insurance company.
What the rich are doing is setting up their own insurance companies, which is called a captive insurance company or 831b.
They are having their shares and ownership of their corporation transferred to the insurance company. Then when they get their monthly or quarterly check, they push that money into the insurance company instead of directing it into their personal bank account.
What you can do with the insurance company is to take that pre-tax money and invest it into things like real estate, stocks, bonds, and even privately held corporations. If you were to do it, to ensure that you aren’t throwing off red flags to the government, you would be investing first in safer things like real estate and with time in riskier ideas.
If this doesn’t seem like a big deal to you, just imagine pushing $1,000,000 into your life insurance company. And then imagine taking that million and investing it in a hedge fund that is producing 20% returns per year.
Here’s what that $1,000,000 would turn into after ten years:
- Year 1: $1,200,000
- Year 2: $1,440,000
- Year 3: $1,728,000
- Year 4: $2,073,600
- Year 5: $2,488,320
- Year 6: $2,985,984
- Year 7: $3,583,181
- Year 8: $4,299,817
- Year 9: $5,159,780
- Year 10: $6,191,736
At the end of ten years, if you decide to pull the money out of the captive insurance company, you would be charged capital gains tax rate of 20%. Plus, if you lived in a state like California, you would be charged 13% for state income tax. That means you would be left with $4,148,463.
On the other hand, if you didn’t have a captive insurance company and you invested $1,000,000 in a hedge fund that produced a return of 20% a year, you would have to pay normal short-term tax gains of 39.6% each year. Assuming you lived in a state like California, you would also have to pay 13% in state income tax.
Here’s what you would be left with at the end of ten years:
- Year 1: $1,094,800
- Year 2: $1,198,587
- Year 3: $1,312,213
- Year 4: $1,426,610
- Year 5: $1,572,801
- Year 6: $1,721,903
- Year 7: $1,885,139
- Year 8: $2,063,850
- Year 9: $2,259,502
- Year 10: $2,473,704
As you can see, $4,148,463 is greater than $2,473,704. Now, just imagine if you did that with $10,000,000 or even $100,000,000. The difference really starts adding up when you deal with larger amounts.
The beautiful part about IRAs is that you can put money in them and save money on taxes, right? Although that’s true, the rich usually avoid traditional IRAs.
Most people put money in IRAs because they assume that when they get older, they won’t make as much money and, as a result, will move to a lower tax bracket. They expect, when they take the money out upon retirement, to pay less tax.
The rich avoid that because history has shown that the government continually raises taxes over time. Also, if you have a lot of money now, chances are you’ll continue to have it in the future.
So, what the rich do is they use a Roth IRA, in which they pay taxes on their money before they put in it. If the IRA happens to grow over 10, 20 or 30 years, they can then pull the money out and not have to pay any taxes on the gains. This strategy is extremely popular with early employees of PayPal. Many of them are using their IRA cash to invest in startups. Once they happen to sell their investements for a billion bucks, they don’t have to pay taxes on the gains.
Tax free corporation
Did you know that the government has a tax incentive for so-called C-corporations? If you setup a C-corporation this year and hold it for at least five years, you don’t have to pay any federal taxes up to $10 million when your company sells.
And if you happen to raise $5 million, you don’t have to pay taxes up to $50 million…assuming you hold it for over five years.
Many people already know about this, but what rich people are doing is setting up multiple C-corporations even if they don’t have a “company” yet. They are just setting up shell companies, and when they have something that produces money, they move it over to these C-corporations so that when they sell it, they don’t have to pay taxes on the first ten million dollars.
Granted, if the company makes money each year, you’ll have to pay taxes on that income, but you don’t have to pay taxes when you sell the business for a large lump sum.
No state income tax
This is one of the most common ways the rich save on taxes…they move to a state with no state income tax. I did it myself around four years ago, when I moved to Washington State and saved a decent chunk of change. Funny enough, I didn’t move to save on state income tax, I moved so I could be closer to a few of my mentors.
When I used to live in California, I used to pay 10% state income tax…since then it’s risen to 13%. In the state of Washington, I pay 0%. Nevada, Florida, Texas, Alaska and South Dakota are other states that have no state income tax.
There’s nothing wrong with living in a tax-free state, but I’ve been noticing lately that rich people are starting to abuse it. Some people “claim” to live in a state with no income tax, but they aren’t really living there. This is mainly happening with people from Southern California as Nevada is a quick four-hour drive.
What they’ll do is buy a home in Las Vegas, switch their driver licenses to Nevada’s and claim they are living there. They’ll then turn their California home as their secondary residence or vacation home…and avoid using credit cards while in California in case they get audited.
To make it seem legitimate, they give one of their credit cards to a friend who lives in Nevada and have them spend a few hundred bucks every month in Las Vegas to make it seem like they are actually living there when they really aren’t.
Invest in gold
The economy may seem like it’s going up, but you already know that it’s artificially inflated. Things seem to be getting better, but the US government is in more debt than it ever has been before, and one day they’ll have to pay it off.
The rich are worried about inflation or devaluation of the dollar. The best way you can protect your assets against the above scenarios is to switch a portion of your cash into gold. Why? It’s because there is only 3.2 Olympic size swimming pools worth of gold on Earth. Assuming people still find it valuable 100 years from now, it will always go up.
What the rich are doing, which is interesting, is keeping their gold off shores. There are places like Das Safe in Austria, which you can actually store gold bars in and not have to report it. On the other hand, if you keep your gold in a safety deposit box in the US, you actually have to report it.
And if the US wants to reposess it like they did in 1933, you’ll end up losing it.
Commercial real estate
One of the best way to decrease your tax rate is to own depreciating assets. One of the easiest assets to depreciate is a commercial building as you can write it off over time, typically, a 39-year period.
So, if you bought an apartment complex for one million bucks, you can write off $25,641 every year from your taxes.
What the rich are doing is buying commercial real estate that throws off positive cash flow plus is section 8 zoned. Maybe what this means is that if you buy apartment complexes in low-income areas that are zoned, the government is subsidizing the rent. So, if a low income tenant lives in your section 8 apartment complex, the government will pay you the rent for them to live in your building.
For you, that’s pretty much guaranteed income. You can’t really get anything better than that.
Moving assets overseas
During the Presidential election, one of the hot topics was how Mitt Romney has millions of dollars tucked away in the Cayman Islands. The Cayman Islands are a tax haven because they don’t charge any taxes.
People like Mitt are moving their money to tax-free countries, while living in the US, and then investing it. As they invest it and make money, they don’t have to pay gains on their taxes each year. At the end, when they are ready to bring it back, they pay taxes.
This strategy is similar to a captive insurance company as you get to play with the government’s money. President Obama is trying to put a stop to this loophole, but the rich are still finding ways around it.
You may read about things like the rich paying lower tax rates due to things like capital gains, which is taxed at 20% instead of 39.6%, but that’s not the real reason they are saving boat loads of money. It’s actually from the tactics above, which most people don’t hear or even know about.
Now, I am not saying you should or shouldn’t do the things above if you want to save money, I’m just trying to shed some light on how the rich are getting richer.
What are some other ways the rich are getting richer?