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3 Tax Breaks That Hugely Benefit the Rich

By Matthew Frankel, CFP® - Feb 16, 2016 at 8:38AM

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It may not seem like these tax breaks favor the rich, but the facts suggest otherwise.

There are several tax breaks that favor the rich, such as the ability to deduct the interest on up to $1 million in mortgage debt. Image: Pixabay.

There are certainly a lot of tax breaks that benefit lower-income individuals, such as the earned income tax credit, retirement savings contributions credit, and the various education deductions and credits. However, there are also several tax breaks that favor the rich, and some are disguised as tax breaks intended to help everybody. Here are three examples, and some information on just how big these tax breaks can be for the 1%.

Mortgage interest
Though it's one of the most well-known tax deductions, you may not think of the mortgage interest deduction as a tax break for the rich. However, keep in mind that in order to utilize this deduction, taxpayers need to itemize -- which is much more common among the rich.

There are other aspects of the mortgage interest deduction that favor the rich. For one thing, the deduction is valid on up to $1,000,000 in mortgage debt. Also, second homes qualify. As you can imagine, most low- and middle-income taxpayers don't own a second home, but many rich people do.

The proof is in the numbers. One study shows that taxpayers with incomes between $40,000 and $75,000 take an average deduction of just $523 for mortgage interest, while those with incomes above $250,000 deduct an average of $5,459 -- more than ten times as much.

Low long-term capital gains taxes
This is another tax break that technically benefits every investor, but in reality, it disproportionally favors the wealthy.

Long-term capital gains are profits made from investments you've held for longer than one year, and they're taxed at a more favorable rate than ordinary income. As of this writing, the highest income tax bracket is 39.6%, while the highest long-term capital gains tax rate is currently 20%, or just over half of that amount.

The richest Americans tend to derive more of their income from investments than the rest of us, and less of their income from wages. In fact, American households with incomes of $1 million or more make up just 0.3% of the population, but this group reaps 70% of the benefit of the long-term capital gains tax rate.

Estate tax exclusions
The estate tax is meant to tax wealthy families, not help them, right? Well, sort of.

First of all, the estate tax only applies to any wealth passed on above $5.45 million -- which excludes all but the top 0.2% of U.S. households. Most of us would consider someone with a net worth of $5 million to be "rich," but such an individual wouldn't pay a dime in estate taxes upon their death.

In addition, there is an annual gift tax exemption of $14,000 per person that allows wealthy individuals to reduce their estate tax liability even further. For example, let's say a 70-year-old with an $8 million estate has three children, all of whom are married, and nine grandchildren, which adds up to 15 people altogether. The annual gift exemption allows this person to give away $210,000 per year to his heirs, which will not count toward his/her taxable estate. After 13 years of this gift-giving, this individual's estate could fall under the lifetime exclusion amount, and they would be able to pass along their entire $8 million estate tax-free.

There are several other ways to get around paying estate taxes, and the end result is that the majority of families you and I would consider to be rich don't pay any estate taxes at all.

The bottom line on these tax breaks
Now, I'm not saying these tax breaks unfairly favor the rich. There are perfectly valid arguments that can be made in support of any of these. For example, high-income individuals paid taxes on their income when it was originally earned -- so, why should they be taxed on the same income again when they pass it on to heirs? Being able to deduct mortgage insurance encourages homeownership for all Americans. And, low long-term capital gains rates encourage long-term investments from everyone, not just the wealthy.

However, the numbers don't lie -- the wealthiest Americans definitely reap more benefits from these tax breaks than everyone else.

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