Top Strategies Millionaires Use To Pay Less Tax Than You

Top CEOs earn billions annually but pay only a fraction of the tax rate applicable to the average Joe. How? Well, they often structure their salaries so that a portion of their compensation is deferred or paid as stock options to avoid taxes immediately.

Meanwhile, seasoned investors invest across asset classes like real estate, commodities, and stocks. This allows them to diversify market risks, benefit from capital appreciation, and generate passive income streams via interest payments, dividends, and rents.

I talked to Justin Rush, CFP, whose clients include HNIs. He explained that “the Qualified Small Business Stock (QSBS) exclusion allows individuals to exclude a portion of the gains from the sale of qualified small business stock from federal taxation. Ultra-high net worth individuals may invest in eligible small businesses to take advantage of this tax benefit.”

You can avoid paying taxes at all on capital gains if you sell real estate and reinvest the proceeds into a different property via a 1031 exchange. This exchange enables real estate investors to trade one investment property for another.

Johan Garcia, CFP, runs After Tax Cash, where he provides tax strategies for real estate and many other topics. He told me that most wealthy individuals have real estate in their portfolio, usually commercial real estate. By reinvesting profits from selling a property into another property via a 1031 exchange, the ultra-wealthy can “defer taxes indefinitely, preserving capital for further investment growth.”

And this isn’t the only strategy to defer taxes with real estate. Garcia explained that Investing in Opportunity Zones Real estate “can offer deferred and potentially reduced tax on capital gains realized from other investments, along with tax-free growth for investments held for at least ten years. While it encourages long-term investment in economically distressed areas.”

As per the US Economic Development Administration, opportunity zones or Qualified Opportunity Zones (QOZ) are “an economically distressed community where private investments may be eligible for capital gain tax incentives.”

Holding onto an opportunity zone investment for five years can lead to a 10% capital gains tax exclusion. After seven years the exclusion is 15%, and after 10 years, 100%.

The backdoor Roth IRA is a popular tax-planning strategy HNIs use to get around income and contribution limits and avoid paying taxes on future withdrawals. Retirement investment vehicles like traditional IRAs grow your pre-tax contributions tax-free and let you deduct contributions from your taxable income. You are taxed on your withdrawals, which is penalty-free after the age of 59½.

Roth IRAs, meanwhile, grow your post-tax contributions. Unlike traditional IRAs, withdrawals from a Roth IRA are tax-free without conditions for any required minimum distributions. However, to open or fund a Roth IRA, single filers’ modified adjusted gross income (MAGI) must be under $153,000 in 2023 or $161,000 for this financial year. For those married or filing jointly, the MAGI limit was set at $228,000 and $240,000, respectively, limiting many higher-income taxpayers.

To avoid the income limits for a Roth IRA, they create a backdoor Roth IRA by converting their traditional IRA to a Roth IRA. There is no income limit for participating in a traditional IRA or restrictions on who can convert IRAs.

When you roll over as much money as you want from your existing traditional IRA to a Roth IRA or completely convert your IRA, you will owe taxes on your pre-tax, traditional IRA contributions, and any capital gains until the conversion date. That’s it: you only pay tax once during the IRA conversion and never again on your backdoor Roth IRA funds.

A Roth IRA isn’t right for everyone, though. If you want to know whether it’s right for your specific circumstances, see how a Roth IRA compares to alternatives.

In 2024, you can give $18,000 as a gift without attracting taxes under the annual gift tax exclusion. Imagine you have three kids and six grandkids; that is $162,000 you could collectively pay them out of your earnings or equivalent estate annually, completely tax-free!

However, gift tax rates on amounts above the annual gift tax exclusion limit range from 18% to a whopping 40%. This can be avoided, too.

In 2024, the IRS allows you to transfer up to $13.61 million in assets or property during your lifetime or as a bequest after death without incurring any taxes. If your gift amount exceeds the annual exclusion limit, report it using IRS Form 709. The difference is deducted from your lifetime exemption limit, and no taxes are owed.

The current estate and gift tax exemption limit will retreat to the previous $5.49 million by the end of 2025 unless the US Congress intervenes. You can even pay for health insurance and care costs or your child’s tuition fees directly to the school without attracting any taxes on the amount.

“Many of our high-net-worth clients will structure assets and engage in wealth transfer strategies to minimize estate taxes upon death. Techniques such as gifting, trusts, and family limited partnerships can help preserve wealth for future generations while minimizing estate tax exposure,” said Justin Rush, CFP.

Making charitable cash and non-cash donations via trusts and charities has long allowed the rich to take advantage of tax breaks. You can make itemized tax deductions from your cash donations, up to 60% of your adjusted gross income (AGI). You can even deduct up to 100% of your AGI for cash contributions to qualifying institutions under Section 501(c)(3) of the Internal Revenue Code.

Justin Rush, CFP, explained that “Ultra-high net worth individuals may establish private foundations or donor-advised funds to support charitable causes while reducing their tax liabilities.”

He added that Charitable Remainder Unit Trusts (CRUTs) may be used by HNIs to provide themselves with an income during their lifetime, with the trust’s assets going to charitable organizations after that.

“This setup offers potential income tax deductions for the donor, as well as the ability to defer capital gains tax on appreciated assets contributed to the trust. They serve as effective estate planning tools that support philanthropic goals while providing income and tax benefits to the donor and beneficiaries”, Rush explained.

The Tax Cuts and Jobs Act increased the standard deduction to $12,000 for individuals and $24,000 for those married. Since charitable contributions must be itemized while filing taxes, the average filer must deduct amounts exceeding these limits.

Millionaires who significantly trade in real estate often secure a Real Estate Professional Status. This status can come with substantial tax benefits, though to qualify, individuals need to spend more than half of their personal service time in real property trades or business, equating to at least 750 hours.

As Johan Garcia explained, the ultra-wealthy often combine REPS with 1031 exchanges, “allowing them to deduct real estate losses against other ordinary income, reducing ordinary income from other sources and investments received.”

The IRS also laid out the various assets that can be depreciated only if used for business or income-generating purposes, like cars, furniture, real property attached to land, equipment, machines, patents, copyrights, and even some software. The maximum expense deduction was $1,160,000 for business properties in 2023 and $1,220,000 in 2024.

Taxes on capital gains stood at 37% for the top federal tax bracket—a big chunk if you are generating significant money from trading.

HNIs involved in stock investing often use a method called tax loss harvesting, which reduces their annual tax liability.

Garcia said tax-loss harvesting “involves selling securities at a loss to offset capital gains in other parts of the portfolio. It's a common tactic to reduce capital gains taxes when, in a year, you have significant capital gains from other investments.”

Further, if losses exceed profits, you could use them to deduct up to $3,000 from your ordinary income.

Hiring your kids for legitimate work to transfer part of your business income via salaries opens up several tax benefits. You’ll be passing wealth to the next generation, but the salaries you pay them will be deductible as business expenses.

This way, you lower your taxable business income and, subsequently, the taxes you pay. On partnerships and sole proprietorships owned by a child’s parents, the IRS said: “Payments for the services of a child under age 18 are not subject to Social Security and Medicare taxes.”

Furthermore, your kids’ income isn’t taxable if it stays under the standard deduction of $13,850 for the tax year 2023 and $14,600 for 2024.

So that’s how the millionaires are doing it. But can the average citizen like you or I learn anything from them to reduce taxes?

Well clearly, some of these strategies are beyond the reach of the man in the street. Most of us don’t have the resources to hire our kids or achieve Real Estate Professional Status. But even the average investor can use tax loss harvesting techniques.

As Justin Rush said, “While some strategies can be very complex, many of the strategies used by high-net-worth individuals are also applicable to the average investor. Along with a financial & retirement plan, everyone should also have a tax plan in place. Being proactive when it comes to tax planning can result in huge savings over the long run. As we like to say: Tip your servers, not the IRS”.