The U.S. tax system is designed generally to tax wealthier Americans more heavily than those earning low incomes. Yet even though features like progressive tax rates put upper-income taxpayers into the highest brackets, many favorable tax provisions benefit the wealthiest Americans in ways that offset their tax bills substantially. Below, you'll learn about three particularly big breaks that the wealthy use consistently.
Low capital gains and dividend tax rates
The tax system favors certain types of investment income with preferential rates, imposing less tax on long-term capital gains and qualified dividend income. If you sell a stock you've held for longer than a year, top-bracket taxpayers who would ordinarily pay 39.6% on their income only have to pay 20%. That savings of nearly 20 percentage points is nearly the biggest available break for taxpayers using the provision.
Similarly, dividend income from many stocks qualifies for that same 20% rate, even for those in the top ordinary income tax bracket. For the recipient to qualify, the company paying the dividend must be a U.S. company or trade on a major U.S. stock exchange. Certain types of special entities, such as real-estate investment trusts and master limited partnerships, don't necessarily qualify their investors for lower dividend tax rates, but for investments that do, the savings are substantial.
What this means is that those who can live off their investments will wind up with a lower tax real rate than those who work for salaries and hourly wages, which are subject to regular tax rates. Only the poorest Americans, who land in the 15% tax bracket or lower, pay less than the wealthy who live on capital gains and dividends. That leaves many middle-class taxpayers in the 25% bracket, which kicks in at just $37,450 of taxable income for single filers, with a greater relative tax burden than the ultra-rich.
No Social Security payroll tax above the "wage cap"
An even bigger inequity in the eyes of many is the fact that the payroll tax system for funding Social Security is regressive. A 6.2% tax applies to employee earnings and is taken automatically out of most workers' paychecks. But the tax only applies up to wages up to a certain amount -- for 2015 and 2016, it's $118,500. Above that level, the wealthy pay no additional payroll taxes.
The trade-off is that the wealthy also don't earn any additional Social Security benefits, so in one sense, it could be viewed as fair not to tax them more if they will receive payments that are no greater from Social Security when they retire. Nevertheless, that argument didn't stop lawmakers from removing the wage cap on Medicare's payroll taxes, which used to have the same wage-base limits as Social Security.
Higher exclusions from estate tax
Finally, wealthy Americans have seen the amount they're able to protect from the estate tax rise dramatically in recent years. Those who pass away in 2016 will get a lifetime exclusion from estate taxes and gift taxes of $5.45 million. That's up from $2 million in 2008. So for estates less than that, no federal estate taxes are due at all. Moreover, the maximum estate tax rate has fallen from as high as 55% at the turn of the millennium to just 40% now.
Other changes have made the estate tax less onerous as well. For instance, portability of exclusion amounts make it possible for married couples to shelter twice the exclusion amount, or $10.9 million for 2016, with much less complexity than was required in the past.
The other big benefit of the current estate tax rules is that in exchange for potential tax, heirs get a step-up in basis on assets they inherit. They are not assessed for the capital gains those assets earned before they inherited them, meaning they get a break from even those low capital gains taxes. Those with truly massive estates still have to take more care and do more planning, but they have good tax reduction options at their disposal.
The wealthiest Americans usually pay a lot in taxes, but they can take advantage of favorable tax laws that can ease their burden considerably. Some believe that those tax laws should be changed, but for now, they're available for those looking to plan and reduce their tax bills.