If you want to fully exploit the tax system as Donald Trump does, this is what you do: Set up your own business, either as a private company or as an independent contractor.
The U.S. tax system is full of breaks that will let you slash how much you pay to Uncle Sam, but almost none of them are available to working stiffs like you and me who live on salary, wages or tips and file a W-2 tax form every year.
And, no, that’s not a bug of the tax code. It’s a feature.
This week The New York Times revealed that Trump had written off more than $1 billion in losses against taxes between 1985 and 1994, and paid no federal income taxes in eight out of the 10 years.
Tax avoidance as sport
The president, who has previously boasted that avoiding taxes successfully made him “smart,” doubled down and called getting around tax obligations “sport.”
When I took my tax exams, years ago, I was struck by how much we really do have two tax codes in this country: One for working people, and one for working the angles. To the IRS, alas, not all money in and money out is the same.
Those in regular employment are taxed as if they’re living in Europe (only without the welfare state). It starts with “FICA,” a flat 15.3% income tax rate, that kicks in on your first dime and goes up from there. A well-paid doctor, lawyer or business person in many parts of the country can be paying well over 40% in marginal income tax rates.
Meanwhile, some people who are making vastly more money pay top rates between 25% and, yes, 0% in taxes, thanks to a range of incredible breaks. Many of those people don’t even show up in the IRS’s annual tax statistics reports, because they don’t have to report any adjusted gross income at all.
A salaried person who earns $1 million, and then loses $1 million in the market, isn’t a guy with zero taxable income. He’s a guy with a taxable income of $1 million. He can’t deduct capital losses against income beyond a pitiful $3,000 a year. He can’t deduct gambling losses against income at all. Oh, and the IRS hasn’t even indexed that $3,000 to inflation, so it’s worth less and less each year.
Meanwhile, if you’re independent, you may be able to write off all your losses against your gains, depending on how you manage to define your business.
401(k) retirement plans
Wage slaves can deduct only $19,000 tax-deferred to their company’s 401(k) plan, plus whatever pitiful “match” your employer still offers. And your company 401(k) plan is probably restricted to a few mediocre mutual funds too. (They’re chosen to limit employers’ potential liabilities, not to help you save for retirement.)
Run your own business? The limit is $56,000, or about three times as much. The money comes straight off the top of your income. It’s invisible to the IRS, and doesn’t even count for the alternative minimum tax (AMT).
Salaried teachers aren’t just buying school supplies these days. They’re doing it with after-tax dollars. On the other hand, if you’re running a business, everything from “depreciation” of assets to a “working” trip in Florida is a big, fat deduction.
Last year Congress even started shutting down one of the most valuable tax breaks left to the middle classes: the deduction for state and local taxes. They’re limited to $10,000, and that, too, isn’t indexed.
You can still deduct the interest on a mortgage up to $1 million, which at current rates may come to about $40,000 a year. But you’re going to pay more for property taxes.
In a situation like this, it’s surprising more regular Joes and Janes don’t do more to scam the system back. Especially now that the person who’s actually running the federal government says it’s OK.
Who gets caught
The risks they’d run would vary. A review of reported federal cases shows that those who get caught and punished for tax evasion are typically those who committed large and blatant fraud, and who left a paper trail that prosecutors could follow.
Meanwhile, there are probably plenty of others who are deducting outlandish values for the old clothes, furniture and knickknacks they give to charity.
Try to claim fictitious losses on stocks and bonds, and there’s a paper trail that can be used against you. Claim them on gold bullion, say, or cryptocurrencies like bitcoin BTCUSD, +3.16% and who’s to say? If you get away with it, you can use them to offset any capital gains, or to reduce your taxable income by $3,000 a year.
Even if the IRS audits you, you can just say you lost the receipts. You’ll pay the taxes and interest, but probably no more. Oh, and the Internal Revenue Service admits it audits just 0.5% of tax returns, or one in 200. So it probably won’t happen anyway.
Brett Arends is a MarketWatch columnist.
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