- Hey, guys, Toby Mathis here with Anderson Business Advisors. Question we get a lot is how do the rich pay such little amounts in taxes, and I'm going to clarify this. We're going to talking about
federal income taxes, first off. And I'm going to show you the difference between the types of income, and then it becomes very, very apparent, once you kind of know
some of the basic rules. And you're going to be
like, "Why don't I do that?" Saying that for years,
"Why don't you do that?" You can, absolutely. So let me just jump right on it. I'm going to switch over my screen. I'll put myself up in the
corner for as long as I can. But I'm just going to kind of go over the income types, first off. So we're going to go income types. You're ready, you're going to jump in. You're ready to get your one-day MBA. Here's the basics. Number one, we have active ordinary. This is the, let's see if
I could spell it right, this is the type of income that you make when you're working. This is the type of income that you make when you're a contractor. So if you're doing Uber or Lyft, this is the type of income
you're making when you're W-2. And what the real important
thing is, when they say active, it means it's going to be subject to FICA, Social Security, or Self-Employment, they're all the same thing. Old age, disability, and survivors, and hospital insurance, Medicare. And this little chunk here is 15.3%. And what's interesting is,
I'm going to put it in red, that this accounts for more than 33% of all U.S. taxes, federal taxes. So I'll just say this little
guy right here is a big one. So it looks like a small amount. And what I always say is
that it's a regressive tax, because it hits people lower
income disproportionately than the folks that make a lot of money. And it phases out. The old age, disability, and
survivors portion phases out at about 150,000. So it's one of those taxes
that we don't like it. But if you work for
McDonald's, for example, I worked in McDonald's when I was 16 making about four bucks an
hour, it's 4.15 an hour, but I got hit for FICA on every dollar. The rest of it goes into your ordinary graduated tax bracket. So the ordinary rate, ordinary just equals that zero to 37%. Here, I'll pull this down
a little bit, there we go, zero to 37%. So when you see ordinary tax,
that's what you're doing. It's the more you make,
the more they take. It goes up. The amount that they
pull out gets up higher. So if you're making over half
a million dollars a year, you're paying the 37% federal. Your state isn't on top of that. So some of you guys in
Connecticut, in New York, in California, you're
just getting torn up. You're getting about
half of your money taken when you're making this type of income. The second type of income
that I want to talk about is a category called portfolio. And portfolio income really has three
different types, subtypes. So I'm just going to call them A, B, C, D. Let's just say A is royalties. So if you write books, if
you create video games, if you're doing something where you're getting some sort
of income stream off of it, you're getting a ordinary income, but no FICA. SS, or SE. Now there's one little caveat on there, is that if you're getting
an advance on a book, like you're getting an
advance to write the book, then that would be active ordinary income, because you're actually doing something. But once the book's out, and you're getting copyright income, none of this guy. None of the Self-Employment tax
anymore, or Social Security. So there's royalties, there's interest. If you make interest, it's
also going to be ordinary. The next category is dividends. And I always say this is rich guy income, because here's what's
interesting about dividends. If they're qualified dividends, so I'm assuming you're U.S. stock market, then it's taxed as
long-term capital gains. And I'm going to go over
what that is in a second, but I'll just let you know
it's zero, 15, or 20%, depending on your income. So for example, if you're
making less than $80,000 a year, your capital gains rate
is a big whopping 0%. If you are somebody in the mid-level, so let's just say 80 to 500,000-ish, you're going to be 15%. And then if you're in
the highest tax brackets, you're going to be at 20%. So it becomes really, really simple. The last one is capital gains, and there's two flavors. Flavor one is short-term. Oops. Which is less than a year of holding, or 40% of 1256 contracts. That's just futures. You don't have to remember that. Just remember that short-term
is less than a year. You hold something less than a year. This will be taxed as short-term gain. Long-term, which is the one
that's most interesting, is one year above or 60% of futures. And this one's the zero, 15, 20%. Short-term is ordinary. So I'm going to get my little red out, and I'm going to say, look at
this one, look at this one. So we automatically have dividends, and we already start
looking at capital gains. And believe it or not,
that's where the wealthy make a ton of their money. Surprise, surprise. In other words, we can
see that it's cut in half. Instead of 37%, you're at 20%. Now, there is something called
the net investment income tax that gets piled on, and it's 3.8%. That will be on the highest bracket. So realistically, think of it as 23.8%. Last type of tax, then I'll show you how
this stuff interplays, is passive income. And there's two types. There's rents, and there's businesses with no material participation. So I just call this being
a silent business owner. So you're not doing
anything in the business. I'll just call that silent. And both of these are ordinary. And why it's really
important is that on losses, for example, in real estate, you can create some paper losses with something called
accelerated depreciation. Those losses can only
offset other passive income. So passive losses can only
offset other passive income. And there's a couple of exceptions where you're an active participant, and your income's low
enough, under 100,000, or you're a real estate pro. Now, there's little nuances in all these. There's a few little
exceptions, like in real estate. If I'm doing Airbnb, and I'm
three days average rental, like I'm just churning
people through there, they're going to treat you
like an ordinary income. They're going to say, "Oh, you're
an active ordinary business." Unless you're not
materially participating, you have somebody else do it,
which case you become passive. But they'll pop up, and then back down. But it won't be rental income,
it'll be something else. And the reason that's important is because if it's a something
else and it's active, then you could use it to
offset any type of income. And rich people are really,
really good about doing that. So I'm just going to put myself
back up on the screen here, make that thing go away. And say we now have identified a few different types of income sources that are tax-advantaged. Now here's what's the real truth on this is the things you didn't notice up there. What you didn't notice up there is you don't have to pay tax on loans, like loan proceeds are
not an income source, if you noticed. So let's say that I am
a guy named Elon Musk, and I have billions of
dollars of stock in a company. One of the easiest ways
for Elon to avoid tax isn't to mess around with
any of the income sources. He doesn't really take much income, but he has capital
assets that could be used as security on a loan. Like if somebody is looking at Elon, saying, "Ah, I'd like
to loan you some money," they're going to enter into a note, and say, "Hey, I'll loan
you the money, Elon, "I know you're going to pay me back. "But just in case, let's secure
it with some real estate, "or some stock." When you do it with stock, it's called a security
backed line of credit. What's interesting there
is there's no tax for Elon. So Elon could borrow a billion dollars off his stock portfolio, probably has, and does not have to pay
any tax on that money. Anybody could do this. So let's say I have, I remember
I was just looking at UBS. And one of the things that they had is, say you have an account. It could be 250,000. I imagine that you're probably better if you're 500,000 or something like that. But they'll generally allow
you to borrow up to half of it off of your stock portfolio, because they know that stocks fluctuate. But even in the worst year in 2008, stocks only went down 38%. So they're secure. They may go a little
higher in some places. But what they're doing is
giving you a line of credit, saying, basically, "Hey, you
can use these as security. "We'll give you money." And right now money's pretty cheap, and the stock market's been on fire. So you could still be
having your portfolio grow, and still have access to
cash for other things, even living expenses. Because like, hey, maybe
you're going through a period where you're developing a
new business or something, and times are tight, and you can borrow
against things like that. People borrow against
their houses all the time. And all it is, is just a
different type of security. So that's one of the things
the wealthiest folks really do. Now, here's the truth
of what the wealthy do, is they understand, and
I'm going to zip over to another screen. And I'm going to take
my face off, actually, so you can actually see
the actual strategies. But let's just say that
you have rich people, and they got bucks galore. Rarely do the rich people just pay tax on that money. What they're good at is like
our president right now did, is having royalties, and things like that. They'll go into an entity. So it'd be an LLC, an Inc, or something, so that it can avoid, like in
the case of President Biden, he just had monies that
would have been subject to active ordinary income, go over, and get converted via an S Corp into something that no Social
Security on any of the profit. So there's no Social Security,
so they can avoid, and save. I'll put some green dollars over here. That's some of the money that
they saved by doing that. So you could do that. Like in this case, that was an S Corp. But you could also have
it just go into a C Corp. And a C Corp right now has a tax bracket that's like, we'll see where it ends up, but it's 21% right now. But it we'll see where it ends up after Congress gets done with it. It might be 25% or something like that. But you're sitting there
at a flat tax rate. The other thing, if it
goes into a business, is that then you could
pay out other people. Like, hey, I could pay out kids, I could pay out employees,
like other employees. I could pay out my, like if my
parents want to come to work. And then their tax bracket could be less. So let's say that I pay it to my kids. So I'm going to say ordinarily
I'd be paying your tuition for college or something like that. I'd be paying it from
out of my tax bracket. So if I'm in the highest tax bracket, for every dollar I spend, I
have to make like, 1.45, 1.50. I got to really make some money, to have something left,
because this category, you earn, you pay tax, and then you spend. Over here, it earns, then it spends, then it's taxed. And it can spend it on these guys. And these guys when they're making money, let's just say that instead
of, like, if my daughter, I'll give you guys a real life situation, pay her through my business, have her doing things for the business. She makes $10,000. She paid 0% tax, 'cause it's
below the standard deduction. If I was to pay that
$10,000 to her for tuition, I'd be paying close to $15,000. Like, I'd have to make about 15, and then I'd pay a bunch of tax, and then the rest would go over there. So that's number one, is they've figured out
that there's these things. They've also figured out
that there's 401(k)'s, and defined benefit plans, and IRAs, which rich people really don't
get to use the IRA as much. But they're doing other
things with their money where this is a 0%, and they're running it from here to here. Again, you have to have a business that's going to run it through. So let's just say that
we have a bunch of money going into, let's say
it's a million dollars. And you're like, "Oh my god, I'm
going to get killed in taxes. "I'm going to pay $370,000 in taxes." It's only on what ends up flowing down to your return or how much you get paid. I could actually get a huge chunk of that. So like defined benefit plans, we base them off of your
current income in age. And we reverse engineer how
much has to go into the, here, I'll put myself back up here, on how much has to go into the plan based on your year, your age, and how much you should be receiving to stay consistent with
your income source. So for example, if I'm
making $200,000 a year, instead of saying, "Oh, you
could put 58,000 a year in," what they do is they say, "Hey," now, you get an actuary
who runs the numbers, and says, "Hey Toby, you're, X-years old, "and you're making $200,000 a year. "How much are you going to have to have "in your retirement plan "to get $200,000 a year
out when you retire?" So reverse engineer it. So if I'm 60 and I have
not that many years left, I might be putting 500, $600,000 a year into my retirement plan. So, in this situation, that little 600, let me pull this down so
you can actually see it, but let's just say that in
this particular situation, we could have $600,000 pop in over there. Rich people understand that. They're very, very good
at doing things like that. Now let's go there one other way. So the other thing that
wealthy people have figured out is that if they buy capital assets, not only do you not pay tax
when you borrow against it, but they also step up when they pass, so they don't pay any tax
during their lifetime. But there's something called depreciation. That is a deduction. So if I have a capital asset
that's a million dollars, and I can deduct, let's
just say I was able to deduct the whole thing,
somehow it all qualifies, and I made a million dollars
up here, I would pay zero tax. Now, if that capital asset
is generating income, so for example, a building
would be a great example, I'll pay tax over time on
whatever amount of that income, after all the expenses,
after the property insurance, after any financing,
after paying any managers, and then after taking my
depreciation, it's whatever's left, I would pay tax just on that portion. What ends up happening
is these deductions, sometimes we can accelerate them. So for example, there's
something called 168(k), that's bonus depreciation. We can accelerate a big
chunk of a building, for example, into year one,
usually about 30% of it, or a single-family or
a duplex or whatever. If you've never heard of it,
it's called cost segregation, and it's very common in
the real estate world. In other words, instead of just saying, "Hey, I bought a building,
or I bought a house, "and I'm renting it out,
and it's 27 1/2 years," you could actually say,
"Hey, you know what, "but the carpet's only five years, "and the cabinets are less, "and the specialty plumbing is less, "and the sidewalk is 15-year property. "The shrubs that I put in are 15." I could choose to break it out. And then if it's less than
20-year property right now under 168(k), you write
it all off in year one. So rich people are really, really good about recognizing that capital
assets are your friend. Not only do they get a better tax rate, but they can help us
offset even other incomes, even other unrelated incomes. If you're a real estate
professional, for example, I could wipe out all of
your income, if I wanted to, off of your W-2 job, simply
by accelerating depreciation. You just have to buy enough
real estate to be able to do so. Then the last area that the wealthy are really good at doing is charities. They're really good about
doing their charitable giving. They understand what
donor-advised funds are, and they understand what
private foundations are, and how they can use them. And they understand what
operating charities are, your traditional 501(c)(3). And they're very, very good about if they're sitting on too much money, so again, I'll bring this guy down. I got a million dollars
that I started with. If it was just me making it,
I'm kind of hosed, right? I could try to get some of
it into a deferred vehicle. But if I have that going into a business, I have an exempt entity here. Here, I'll put a big orange thing. I have an exempt entity here. I can accelerate my depreciation. I'm trying to knock some things out. And I have another exempt
organizations here, where if I have a really
big year, for example, and I'm just, like, it's not common for me to hit a million dollars a
year, maybe it's half a million, but I have a windfall, I may
say, "Hey, you know what? "I normally give 10% of my income away. I like giving it to charities,
I give it to my own charity, whatever the case, you could throw it in a donor-advised fund and
piece that out over years, but take the deduction now. Or you could throw that
into a private foundation, and write off a big chunk. If it's half a million, and
we'd have a 50% threshold, we probably wouldn't
be able to do it there. We'd be limited to 30%. But if it's a regular charity, you could go up to 100% of
your adjusted gross income, dumping it straight into a charity. So that's why you're always
seeing rich guys and rich gals with their foundations
and their charities. A lot of time it is benevolence, but there's also an incentive
built into the tax code that says to these people, "Hey, if you want to defer tax, "or if you want to avoid it
entirely, it's up to you. "Here's some vehicles,
here's what you can do." And so if I'm sitting
on a big chunk of money, and I have to decide do
I want to pay tax on it, or could I write it off? I'll find a vessel to write it off in, and worry about if there's
ever a tax situation for it coming back out in the future. My experience with 501(c)(3)'s is that for the wealthiest
folks, the money goes in, and it doesn't come back to them. They don't want it. They just don't want to
pay a huge amount in taxes, and they want to have
control over that money to be able to do good things in society, and they don't necessarily
think that governments are the best at doing it. So I personally feel the same way, and I see a lot of people
doing a lot of great things. You just give them that incentive. So we just covered a whole bunch of things that the wealthiest people could do. I'm sure it's a little different. A lot of people just say,
"Hey, what are the deductions?" Deductions are for any business. There's going to be little caveats, like there's certain deductions
that work for a C Corp that don't work for an S Corp. There's certain deductions
that you're really going to raise a red flag on
if you're a sole proprietor. There's things that you could do there. I'm not talking necessarily about that. I want big chunks. So what do the wealthy do? They're not worried about
writing off their mileage nearly as much as they want
that million dollar deduction, and how do they get it. And that's where you get into the realm of defined benefit plans,
accelerated depreciation, charities and using charities,
using advanced tools. There's even some really cool things that you could do with private insurance, and some things along there. There's a huge universe
that gets opened up once you start looking at
the wealthiest Americans, and the different types of tools that they have available to
them from a tax standpoint, to usually, there's a kind
of an incentive layer to it, as, "Hey, we want you to be investing "in these types of things." And so there might be tax credits, there might be accelerated
depreciation, other things. And that's where the wealthy
are putting their money, because they're saying,
"Hey, if it's tax-advantaged, "then I get even more. "But if I'm having to spend my money "that I'm investing
with after tax dollars, "they just took half of it. "I'm playing with half the
money that I don't ordinarily "get to play with," and it
becomes not as attractive. So if you can kind of follow along what these folks are
doing, they're just saying, "Hey, if I could save the 50%, "this is a much more palatable investment, "and I have a much bigger tax appetite, "so I'm going to go into
them," and that's it! Hey, if you like this type of information, like this video, and subscribe. We're constantly putting out information to help you keep more
dollars in your pocket, sometimes to just demystify things. So like when you see
really horrible articles saying that billionaires
don't pay their fair share, you understand why,
and what the rules are. And as to whether they're good or bad, that's a matter for Congress. But we shouldn't be demonizing people just for following the
rules as they're written. Because again, you can see when something is actually incurred, and
what type of income it is. And you go, "Oh, it's that type of income. "That's why they're paying so low on it. "I get it, and I can do it, too. "I think I'm going to do what they do, "and not be too upset about it," and say, "Hey, I'm thankful that Congress "gives me incentives to be an investor, "gives me incentives to
get into real estate, "gives me incentives to give
away money to charities, "gives me an incentive to
even operate a charity." All those things are pluses. Instead of griping about
somebody else using it, I might just do what they're doing.
