Why the Wealthy Pay Less Income Tax

The Presidential election has brought attention to the fact that many wealthy people in the U.S. pay little income tax. Experts suggest that the issues discussed in the election are not the biggest reason for the phenomenon.

During the course of the Presidential election cycle Donald Trump has received criticism for breaking tradition and not releasing his income tax returns. While he has said it is because he is under audit, his opponent speculated that his returns might reveal that he did not pay income tax at all or that he is not as wealthy as he claims. Some of the mystery was solved when the New York Times published three pages from his leaked state tax returns from 1995.

The returns revealed that he could have avoided paying any federal income tax for up to 18 years because he had taken an almost $1 billion business loss that year. Trump seemed to confirm that was the case during a debate with Hillary Clinton.

However, as The Atlantic points out in "The Tax Code for the Ultra-Rich vs. The One for Everyone Else," the reason Trump pays little income tax is not the reason most of the wealthy also pay little.

The bigger issue is the way in which capital gains are taxed or in some cases not taxed. Capital gains are not taxed until they are realized, that is until the underlying asset is transferred. If the owner of the asset passes away without having sold the asset, then his or her heirs receive the asset with a step-up basis. They do not have to pay capital gains on any increased value of the asset that accrued before they received it when they decide to sell it.

As part of his plan for estate tax reform, President Obama has proposed eliminating this step-up basis.

Whether or not you agree with the wisdom of the current laws that allow many wealthy people to pay little in income tax, it is important to know the real reason it happens because that is what politicians are likely to be looking at when the estate tax comes up again in Congress.

Be sure to speak with a certified California estate tax planning attorney for your particular situation. Visit our website for more information, or call 800-220-4205 to speak with a California estate planning attorney in Orange County, Corona or Long Beach.

Reference: The Atlantic (Oct. 15, 2016) "The Tax Code for the Ultra-Rich vs. The One for Everyone Else."