Written by: Shruti Shahare
"Debt is the new way for the wealthy to stay rich, with the distinction between good and bad debt being crucial."
I remember when I was young my dad said debt is not a good thing, debt free = financial freedom. Debt and taxes: Those two words make most people feel anxious and keep many up at night. However, the idea that "all debt" is bad is a misconception. Debt can be an opportunity for the wealthy to become ultra wealthy. Borrowing money to purchase something with a higher return than the interest paid can lead to significant profits. Donald Trump, the most controversial president of the United States, actually knows a lot about debt and taxes. The Duke and Duchess of Sussex, Prince Harry and Meghan Markle, arrived in their 9-bedroom mansion in Montecito, California, after leaving the U.K. in the wake of their well-documented disagreement with the royal family. Their Montecito mansion came with a $14.65 million price tag but, perhaps more interestingly, a $9 million mortgage. Taking on debt to purchase a home, which is considered an asset, frees up cash for other investments with potentially higher returns. Low mortgage interest rates can further amplify the benefits of leveraging debt for real estate investments. Mortgages have tax advantages like deductions for loan interest or property expenses.
Rich people have access to low-interest loans, Interest rates on loans are dependent on credit scores. Those with good credit receive lower interest rates. This allows them to borrow money at favourable rates to invest in income-producing assets. Those with good credit histories receive lower interest rates. For example: Mark Zukerberg got a loan with a rate of just 1.05%. While the average person drowns in tax and debt. Billionaires take advantage and only pay a fraction of their money to pay tax and one way this work is using debt as a leverage. Only profit is taxable for entrepreneurs. Now the way these rich people pay almost 0 taxes is by matching their amount of profit to the amount of expenses they have for business.
When it comes to stocks, you only pay taxes on a stock once you sell it a capital gains tax on the profits. But billionaire giants hold onto their stock this is called unrealized gains, and it is not taxable. Since loans have to be paid back, they do not count as income. And the wealthiest people have plenty of collateral, such as the shares they hold. So, they can hold onto shares, use them as collateral without cashing them out, and get access to cash without paying taxes on it, since it's technically borrowed money.
The rich people retain their wealth differently than ordinary people account for a large chunk of these tiny taxes. Neither is it hidden under the bed nor is it sitting in a bank account; they invest money in securities such as stocks and real estate, which are only taxed upon resale, so it's unrealized and doesn't count as revenue until that time.
The wealthy also employ various tax strategies to legally reduce their tax obligations. While tax avoidance is different from tax evasion and is entirely legal, it is a technique that requires careful planning and execution. Some of the common strategies used by wealthy people are:
1. Tax-Deferred Accounts: IRA, a type of account that shields income from taxes and is intended to help low- and middle-class savers prepare for retirement. Peter Thiel founder of PayPal garnered attention for the strategy he used to grow the account from $1,700 to $5 billion, which he will eventually be able to withdraw completely tax-free.
2. Buying sports teams or investing in their hobbies: Robert Piccinini was a member of a group that purchased the Golden State Warriors basketball team in 2010 for a reported $450 million. Over the following four years, he claimed losses of $16 million — despite the fact that the team's total value ballooned to $1.3 billion during that period. Beanie Babies founder Ty Warner, the billionaire splurged on a couple of landmark Four Seasons locations and then went 12 years without paying any income tax.
3. Philanthropy: Another popular strategy for lowering tax bills. It not only helps billionaires save money but also boosts their public.
Wealth Transfer Strategies: The rich also use debt and tax strategies to transfer wealth to the next generation while minimizing the tax implications. This allows them to ensure their wealth continues to grow and benefit their heirs. Some common strategies include:
1. Family Limited Partnerships (FLPs): A family limited partnership (FLP) is an arrangement in which family members pool money to run a business project. Each family member buys units or shares of the business and can profit in proportion to the number of shares they own, as outlined in the partnership operating agreement. FLPs are a way for wealthy families to pass on assets while maintaining control. They can also reduce the taxable value of assets when transferring them to heirs.
2. Generation-Skipping Trusts and Gifting: These trusts allow wealth to pass directly to grandchildren or even later generations, skipping a generation for estate tax purposes. Any person younger by more than 37.5 years of age than the grantor can be assigned as a beneficiary. Wealthy individuals often make gifts to their heirs during their lifetimes, taking advantage of gift tax exemptions and reducing the size of their taxable estate.
In conclusion, being poor costs more than being rich since you usually have more. The wealthy have mastered the art of leveraging debt and taxes to their advantage to maintain and grow their wealth. An average person keeps working with a minimum wage and paying insanely high taxes when billionaires are getting richer by paying considerably less taxes than the average person.