Billionaire Warren Buffet famously declares he pays a lower effective tax rate than his secretary. This is because many wealthy individuals take advantage of IRS rules that allow them to minimize taxes, primarily through investment income, which is often taxed at a lower rate than ordinary income and avoids payroll taxes for Social Security and Medicare. Investors like Buffet or executives at large corporations can lower their effective tax rate by having relatively low salaries and instead receiving compensation through stock options and dividends.
Armine Alajian, CPA, explains, “Wealthy people don’t only rely on W-2 income. They also have investment income like dividends and capital gains.
Qualified dividends and long-term capital gains are often taxed at rates that max out at 23.8%, compared to regular income tax rates of up to 37%. Additionally, investment income is not subjected to the 7.65% payroll tax.
This means that shifting earnings toward investment income can potentially lower one’s effective tax rate. Wealthy individuals can time their income to take advantage of lower tax rates. For instance, if tax rates are expected to drop in 2026, claiming less income in 2025 and more in 2026 could result in a lower overall tax burden.
How investors lower their tax rate
Business owners can also control income timing by delaying billing until a new tax year to take advantage of potentially lower rates. Instead of just seeking deductions during tax season, wealthy people engage in year-round tax planning.
By projecting their income and planning accordingly, they can utilize available strategies based on different points in time. Wealthy people tend to do tax planning throughout the year to manage their tax liabilities effectively,” Alajian points out. These strategies aren’t exclusive to the wealthy.
Even those with self-employment income can benefit from timing their income and engaging in year-round tax planning. Tools and advisors are available to help implement practices like tax-loss harvesting and income shifting, making these strategies accessible to nearly everyone. While wealthy individuals may inherently benefit more from strategic tax planning, many of the strategies they use are available to all taxpayers.
By understanding and implementing these approaches, you can potentially lower your effective tax rate and maximize your financial well-being throughout the year.
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