GOP presidential candidate Mitt Romney and his wife paid a 14% effective income tax rate in 2010 on nearly $22 million of income. Given the marginal federal income tax rate for anyone making over $35,350 (single) or $70,700 (married) is higher than 15%, it is pretty clear that the Romney’s are paying way below what you would expect. In fact, they should be paying at the top marginal tax rate of 35% if income received was a pure basis for taxation. But, the American tax code is so complicated and riddled with loopholes that if you know the “right” way to earn and deduct income, you can join Mitt and his fellow one-percenters in paying a much lower effective tax rate.
While most of us will never have an annual income approaching $22 million, we can all benefit from legally paying less in taxes. Particularly if you earn more than $35,350/$70,700 and can think longer term. Here’s how Mitt does it, as can you.
Invest wisely, so that your future earnings come from capital gains and dividends – The bulk of Romney’s 2010 income came from long-term capital gains ($12.6 million) and dividends ($8.2 million). This was really why his effective tax rate was so much lower than it should have been, since the highest tax rate on income from long-term capital gains and dividends is typically only15%, considerably less than the top rate of 35% levied on regular salary income.This lower rate on investments was instituted as part of the Bush-era tax cuts to spur investment. Unfortunately, most of the benefit has gone to the richer folks with more in investments, rather the middle or lower income earners whose income is primarily from wages. But by investing in dividend paying stocks over the longer term, you could start deriving a nice income stream over time which would likely be taxed at a much lower rate than your salaried income.
Make tax-deductible charitable donations – The Romney’s made $3 million in tax-deductible charitable donations during 2010. Not only is this altruistic, but it cuts his taxable income by an equal amount. So giving is not only good, it is actually a great tax minimization strategy.
Use tax-deferred retirement accounts like a 401K, IRA or Roth IRA. The Romney’s have also got a lot of their existing wealth in tax deferred retirement accounts. Typically, earnings generated inside IRAs aren’t taxable until they’re distributed. Meanwhile, you can get a nice tax deduction now for the money put into an IRA or 401(k) plan at work. Further, the Romney’s have taken advantage of retirement accounts and estate-planning loop holes to provide a large tax-free inheritance to their kids.
Foreign source income and tax shelters – There are a number of ountries where Americans can park money and reduce what they need to report and pay to the IRS. While this is in the shady area of tax law, Romney was perhaps using foreign source income (based on his Swiss accounts disclosure) as a way to lower US taxes paid. But remember, legally you need to declare all income to the IRS, no matter the source or location. Unless you have access to sophisticated investments or advisors, this is one strategy I would keep on the back burner.
While you may dislike how the Romney’s and other super-rich pay a much lower portion of their income in taxes, the fact is that everyday Americans can in most cases take advantage of the same tax breaks the rich use. The key is knowing about the tax breaks and then planning ahead to take advantage of them.