Billionaire Warren Buffet famously proclaims that he will pay a lower effective tax rate than his secretary. He does this by taking advantage of IRS rules that allow many wealthy people to minimize taxes. For example, investment income is often taxed lower than ordinary income and avoids payroll taxes for Social Security and Medicare.
It’s important to note that being rich does not automatically mean you pay less in taxes in terms of the total dollar amount. The rich tend to pay significantly more. However, the tax rates many wealthy people pay can be lower than what an average worker pays based on strategic tax planning and how they earn their income.
Investors like Buffet or executives at large corporations can often lower their effective tax rate by having relatively low salaries. Instead, they earn much money from stock-based compensation, such as by selling company stock. Wealthy people don’t rely on W-2 income only as employees like most middle-class individuals.
Their income comes not only from W-2 wages; they also have investment income like dividends and capital gains,” said Armine Alajian, founder and CPA. Not all investment income is taxed at favorable rates, but qualified dividends and long-term capital gains are. These rates generally max out at 23.8%, and for low- and middle-income earners, rates can be 0% or 15%.
Even if you do end up paying the top rate, that’s often lower than regular income tax rates, which max out at 37%. Plus, investment income is not subject to the 7.65% employees pay for payroll taxes. The more you shift your earnings toward investment income rather than regular wages, the more you can potentially lower your effective tax rate.
For some, that might mean accepting a job that pays substantial compensation through stock options rather than salary.
Tax strategies for investors
This tax difference can also motivate investors to invest more.
Down the road, you might withdraw some of your investment gains, which might leave you with more money for discretionary spending compared to picking up extra shifts at your job. Timing also matters when it comes to taxes. You might want to lower your income in years when tax rates are high and vice versa.
For example, you might claim less income in 2025, given that tax rates might drop in 2026 if new tax legislation passes. Because many wealthy people don’t rely on W-2 income, they can take advantage of these situations more flexibly. “They have businesses where they can control their losses and profits,” Alajian said.
For example, a business owner might try to wrap up and bill for a client project at the beginning of January 2026 rather than the end of December 2025. This type of income timing is available to anyone with self-employment income, regardless of wealth. Timing is also part of strategies like tax-loss harvesting, where you sell down investments to create a taxable loss while buying different investments that will hopefully be appreciated.
Although you’re generally just delaying taxes in this situation, it typically provides net benefits. With inflation, paying $1,000 in taxes this year is essentially more expensive than paying $1,000 five years from now, so deferring taxes can increase your purchasing power. You don’t have to be rich to tax-loss harvest, as many investment platforms can automate the process for you or a financial advisor can guide you.
Lastly, while you might be looking at your tax situation now as the filing deadline looms, it’s too late for many tax maneuvers that could save you money, as most apply to what happened the preceding year. So, instead of trying to find tax savings during tax season, you might take a page from the wealthy’s playbook. Wealthy people tend to do tax planning throughout the year, in which they project their income and plan around that with different strategies available for their current needs—and this is done constantly throughout the year, every year,” Alajian explained.
You might find ways to shift income, qualify for deductions, and ultimately set yourself up for a smaller tax bill.
Photo by RDNE Stock project on Pexels