Transcription
In this video, I will reveal two strategies that the rich use to pay less tax. By the end of this video, you'll understand how these strategies work and how you could use some of the same principles. I'm a qualified accountant and I've worked for some of the leading UK tax practices over the last 10 years.
Let's start off with the first strategy, which is to increase assets. Most people rely on their salary or their pension as their main source of income, so the government will tell you how much tax you owe and your employer will automatically deduct it, and you have very little control over how much tax you pay. The wealthy do things completely differently because they will take a small salary or pension because they know that income is taxed at the highest rate. And instead, their wealth is tied up in their assets like stocks and real estate.
This is the basis of how the rich pay less tax, and it's why Elon Musk's latest approved pay deal of $45 billion will not be taken as a salary, but instead, it will be taken as stock options because they are a type of assets. And he knows that if he took that $45 billion as a salary, he would pay up to half of that away in taxes to the US government. So, what he's doing instead is he is building and maintaining his assets.
Assets are only taxed when they are sold because that is the point that again is realized. And the effect that has is that if you have appreciating assets that are increasing in value over time, your net wealth is also increasing, but you're not paying any tax until you come on to sell your assets. When you do sell your assets, they will be taxed more favorably than income would be taxed because in most countries, capital gains tax rates are lower than income tax rates.
A report by ProPublica, which is a nonprofit newsroom in the US, says that the top 25 wealthiest Americans reported $158 million in wages in 2018, a mere 1.1% of what they listed on their tax forms as their total reported income. The rest of their income came from dividends and the sale of assets like stocks and bonds. Most ordinary people are employees without any control over how they earn their income and how much tax they pay. That's why most ordinary people have higher tax rates than the wealthiest people, and it's why Warren Buffett famously says that his tax rate is lower than his secretary's tax rate. So, as an employee, you will suffer the highest burden of tax because you don't have access to the loopholes that the rich have because they earn different types of income and they own assets.
But this all still leaves a question: how do the wealthy fund their lifestyles if they're not taking a salary? Where does their money come from? This is where the next strategy comes in, which is buy, borrow, die.
So, the super-rich don't want to take a salary. They may take a dividend if they have their own companies, but what they do have is a lot of assets. But they don't want to sell their assets to produce income because they want those assets to continue growing in value so they can pass them on to the next generation and to avoid triggering a capital gain. So, what they'll do instead is they will borrow against their assets using something called a securities-backed line of credit. This is the way the super-rich fund their lifestyles without having to take a large salary and pay high rates of tax.
So, let's talk about how this would work using an example. Let's say that you are a company owner and your company is very successful, so your shares are very valuable. Firstly, the "buy" part of the strategy means buying assets that appreciate in value. In your case, that's the company stock that you hold in your own company. It could also include real estate or stocks in other companies that you hold as part of your investment portfolio.
The next part is to borrow against those appreciating assets. So, rather than selling your company stocks to generate some income, you would borrow against the stock that you hold in your company. And loan income isn't taxable, so you get to avoid paying any income tax that you would usually pay if you had taken that income as a salary from your company. Instead, the interest on the loan will also typically be lower over the long term than the tax that you would have had to pay if you had taken the income as a salary. You will then use that loan to fund your lifestyle.
The third part of the strategy is "die." So, when you die, you will pass your assets onto your heirs as part of your estate, and your heirs will use those assets to pay off the loan that you took out. That means that they avoid paying for the loan out of their own pocket. And the other thing that will happen is that the assets that you pass on to your heirs will have an uplift in their base cost to market value. So, that means that any appreciating assets that you passed on to them will increase in value, and the unrealized capital gain that you had in your lifetime will be completely eliminated. So, it minimizes the capital gains tax that your heirs have to pay. Essentially, your heirs take on the assets at the market value at the time that you died. And this strategy can be repeated again and again to minimize the capital gains tax that will ever be paid on your assets.
The main tax that's avoided by doing this is capital gains tax because you don't have to sell any of your appreciating assets, and when you die, your assets are uplifted to market value, which again eliminates part of the unrealized capital gain. The other tax that you minimize is income tax because you don't need to take out a dividend or a salary from your business, and those types of income are the ones that typically have the highest rate of tax, so you avoid that altogether.
This strategy is popular in the US amongst the super-wealthy, but it is risky. Peloton founder John Foley used this strategy when he used more than 20% of the Peloton stock that he owned as collateral for his personal loan. But the Peloton stock value fell, and the bank, Goldman Sachs, placed margin calls on the borrowed money, which meant that he had to provide more collateral for the loan. So, this is a huge downside. If the value of your assets falls, then you might have to provide more collateral or pay off part of the loan in cash.
So, this is how the super-rich pay less tax and preserve their wealth. And you would be right in thinking that to use these strategies, you already have to have a certain level of wealth. But you can use some of the same principles, like relying less on your salary and having the goal of investing more in assets so that you have more control over your tax bill.
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