How Thousands of Wealthy People Pay No Taxes (It's Totally Legal)

By Dan Caplinger

Posted 2:50PM 06/05/12 Posted under: Taxes

With the rise of the Occupy Wall Street movement and its focus on the 1%, the wealthiest people in the U.S. have gotten a lot of attention lately. Yet despite arguments back and forth about whether the rich pay their fair share, one thing is certain: Some high-income earners pay no taxes at all.

A recent IRS study found that one in every 189 taxpayers earning $200,000 or more in adjusted gross income paid no income tax in 2009, the most recent year for which complete data is available. That's more than 10,000 wealthy households paying no taxes anywhere in the world, and more than 35,000 paying no U.S. income tax.

How Did They Swing That?

There are several popular methods high-income taxpayers employ to cut their taxes. The most widely used is to invest in tax-exempt municipal bonds, which pay interest that you don't have to include as taxable income on your tax return.

But itemized deductions also play a key role in reducing tax liability for the rich. Although medical and dental expenses aren't deductible until you spend at least 7.5% of your income on them, some rich taxpayers can use expenses they'd have to pay anyway to offset all of their income. Similarly, deductions for state income and property taxes, as well as charitable contributions, also help rich taxpayers reduce their tax burden.

Idle Threats

The fact that the rich can pay little or no tax under current law has led to proposals to change those laws.

Gallery: Learn From These Celeb Tax Mistakes

Between the so-called "Buffett Rule," which would impose minimum tax rates on high-income taxpayers, and calls to limit the tax benefits from certain popular deductions, the rich soon may no longer be able to escape paying tax entirely.

But in an election year, it's hard to envision such measures getting through Congress to become law -- and unless they at some point do, the rich will still have perfectly legal ways to protect their income from the IRS.

For more on your taxes:

You can follow Motley Fool contributor Dan Caplinger on Twitter here.

Tagged: buffett rule, BuffettRule, Finance, income tax, IncomeTax, IRS, muni bonds, MuniBonds, municipal bonds, MunicipalBonds, Occupy Wall Street, pay no taxes, PayNoTaxes, tax deductions, tax loopholes,

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