Taxation for the Independently Wealthy
Taxes are for schmucks. The independently wealthy know this and have figured out how to live off of the appreciation of their assets, tax-free. This American lives off of the interest from their (parents’) savings. By borrowing against this interest for living expenses then selling the savings to cover the debt on death, this American participates in Tax Planning 101, or Buy, Borrow, Die.
An independently wealthy person isn’t born with a silver spoon in their mouth, they are born with the entire tea set. Although it is not necessary that this person has a gilded upbringing, the shear amount of wealth required to be independently wealthy makes this very likely. From a very early age, this person’s parents will be transferring wealth to them so that they don’t eventually get hit with a death tax (or putting it in a trust). By the time this person leaves their parents’ nest (although, admittedly, they may do so by moving into their parents’ beach house or New York condo), they will have built up a substantial amount of wealth from their parents; likely several million dollars.
At around 18 years old, this poor soul now has the burden of looking after her wealth herself. Fortunately, there are tax advisers who will help them do so - for a large cut, but smaller than the tax man would be taking. All told, it is a good deal for all parties; the rich kid avoids paying any taxes and the adviser makes this look difficult and like an anomaly. It is neither of those things.
If this American’s wealth is not already invested, now is the time. This American takes the built up wealth from her parents and invests it in appreciating assets; think: property, hedge funds, and the like. If her parents are still giving more, then this is invested as it is received. These will ensure that the American is continuing to build her wealth, creating an income stream. This is what consists of work for this person; their entire life’s income consists first of tax-free gifts and second of the appreciation of assets bought with those gifts.
This American now retires about three working days after she receives control of her wealth; it is hard work getting it invested. She will probably be about 18 years old and 3 days. (5 days if her birthday falls on a weekend; imagine how embarrassing that would be among her friends)
She expects that her investments will provide her an income of interest alone that is approximately 3% of the principal. That means that, if her parents gave her $2,000,000, she will receive $60,000 in interest alone. With $2,000,000 invested, this American gets the median American income added to her wealth every year because of the three days of work she put in during her arduous career. (at $6,700,000 invested, her interest alone puts her into the 90th income percentile with $200,000 per year; remember that there are Americans receiving tens, or even hundreds, of millions of dollars this way) If she sells this interest, then she will pay lower capital gains rates on her income. If she doesn’t sell this interest, she won’t pay any taxes, but it also won’t provide any money for her to live off of.
If only she could have her cake and eat it too. Turns out, in a shocking turn of events, in a system built by the rich, she can. This patriotic American simply takes out debt in the amount of her interest and leverages her assets to get the lowest interest rate possible for the debt. Her debt provides the money she needs to buy things like groceries, gas, cars, mortgages, vacations, yachts, more cars, Instagram followers, maybe a plane, jet fuel, and so on. She has not sold any of her assets so she is not taxed on their unrealized gains. Debt is not taxed either. Therefore, until this American sells her assets to pay off her debts, she does not have to pay any taxes on her lifestyle.
Now for her third act, this American pulls off the greatest trick: She dies!
The American lived their 60-year-retirement by taking out debt on the interest of her investments. Some tax advisers recommend doing so also on the principal, in one version of the Die Broke strategy; this is undoubtedly the right strategy with no descendants or spouse, but ill-advised for those interested in passing along wealth to their children (in fact, they should have significantly done so by the time they die, creating another overlapping cycle and the other Die Broke strategy).
Upon death, the remaining assets must now be dealt with. These assets are the investments that she made, with their appreciated, unrealized gains. These assets are then inherited on a stepped-up basis, so that the unrealized gains become the new baseline. The assets are then sold, tax-free, because they have not gained any value since they just stepped up.
Her liabilities must also be dealt with. This is her accumulated debt, which is equal to all of the appreciation of her assets. The proceeds from the sale of her assets, which was not taxed, are then used to pay off her debts, which is never taxed. The $2,000,000 (or $10,000,000 or $100,000,000) principal remains after the debts are paid and is inherited by their children so that they can do the same during the remainder of their life. So the cycle continues.