Tax season has officially arrived, and while that means hassles for many, it also means plenty of refunds. On average, about 80% of taxpayers wind up receiving a refund from the federal government each year.
But, for wealthier taxpayers and households tax season takes on an entirely different meaning. For some well-to-do households, taxes can be an utter nightmare with the wealthy parting ways with a higher proportion of their income. However, in other ways it can be especially rewarding, as certain deductions are particularly geared toward the rich, allowing them to take advantage of tools that can substantially reduce their tax liability.
Today, we'll take a brief look at three of the most crucial tax breaks wealthy individuals and households won't want to forget during the ongoing tax season.
1. Mortgage interest deduction
According to Bankrate, the mortgage interest deduction, which allows homeowners to deduct the amount of interest paid on their mortgage attached to their primary (and possibly secondary) residence, cost the federal government an estimated $464 billion in tax revenue between 2011 and 2015. What's really notable about this deduction, though, is that it generally favors upper-income homeowners.
A study conducted by the Wharton School at the University of Pennsylvania notes that households with average incomes of between $40,000 and $75,000 managed to net a mortgage interest deduction of just $523. Comparatively, households with incomes above $250,000 reveled in an average write-off of a whopping $5,459. For you math-o-phobes that's a 944% increase.
Why such a difference? The vast majority of middle-class homeowners don't itemize on a Form 1040 Schedule A in order to claim the deduction, whereas the wealthy often do. Furthermore, if the rich itemize, they can also claim the mortgage interest deduction on a second home as well. This tax break incentivizes wealthy individuals to buy big homes with the knowledge that they'll be able to use the interest paid on their loan, or loans, to reduce their taxable income.
2. Capital gains
Another critical tax break that wealthy individuals and households will want to consider taking full advantage of is capital gains tax rates.
Imagine this: you've invested money into a stock, mutual fund, or bond, and that asset increases in value from what you paid for it. If you own this asset for exactly one year or less, whatever gain you realize from your sale will be taxed as ordinary income based on the peak marginal tax bracket you fall into. For the wealthy, these short-term gains could result in taxes equaling 33%, 35%, or 39.6%, based on the 2015 IRS tax tables.
Now imagine holding this same asset for a minimum of a year and a day and then selling it. Instead of paying an ordinary tax rate on your gain, you'd be responsible for paying (as a wealthy individual) 15% or 20%, with 20% being the peak marginal tax rate for a long-term capital gain. It should be noted that under the Affordable Care Act, a 3.8% net investment surtax may also apply for individuals with incomes above $200,000, and married filers with incomes above $250,000.
Nonetheless, paying 15% (single filers could make up to $415,050 and still pay just a 15% tax on long-term capital gains) or 20% is a far cry from the 33%, 35%, or 39.6% marginal tax rates. Thus, capital gains taxes really tend to favor wealthier individuals, and it gives these individuals and households a way to preserve and build their wealth faster.
3. Charitable contributions
According to a report from the Chronicle of Philanthropy in October 2014, the wealthy in America wound up donating an inflation-adjusted $77.5 billion in 2012, a $4.6 billion increase from the prior year. Charitable giving is a good thing regardless of income class, but it's a particularly nice tax break for the wealthy.
In addition to supporting a cause they believe in, wealthy individuals are also able to take a tax deduction that's commensurate with their peak marginal tax rate. For example, an individual earning $250,000 per year who sits in the 35% peak marginal tax bracket would be able to take a $0.35 tax deduction per every $1 donated. By a similar token, an individual making $35,000 a year in the 15% marginal tax bracket would only see their taxable income reduced by $0.15 for every $1 donated.
Making smart tax decisions can have a big impact on your wallet by allowing you to keep more of your hard-earned money, potentially speeding up your retirement date and reducing your stress level. Do yourself a favor this tax season (and beyond) and ensure that you're maximizing these crucial tax benefits to keep as much of your income as possible.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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