Tax Structure for High-Income Earners in the U.S
Elon Musk, the renowned entrepreneur, has become a role model for many, inspiring innovation and success. But what is less widely known is the staggering rate of tax he pays. His tax burden provides insight into the taxation structure for ultra-high earners in the United States.
In President Joe Biden’s first budget, he proposed raising taxes on the ultra-rich to cover the costs of programs such as childcare and education expansions. This raised the question of just how much people like Elon Musk pay in taxes.
The top 1% of earners in the US possess a significant share of the nation’s wealth and as a result, pay a higher rate of taxes than lower earners. A professional financial adviser and certified public accountant, Melissa Thomas, explains that high earners pay a top rate of 37% on all income earned above $523,600.
According to the New York Times, those earning over $10 million a year can expect to pay an income tax of 37.1%, making the effective tax rate higher than the top marginal rate. This is due to the additional taxes levied such as the net investment income tax, which applies to passive income.
Estimates suggest that Elon Musk’s net worth is upwards of $120 billion. His primary source of income, Tesla, is an impressive example of an S-Corp which allows him to chooseto set aside $480,000 a year in a retirement plan and pay 1.45% in payroll taxes instead of paying 15.3% in self-employment taxes. This is a significant saving for the high-earning entrepreneur.
However, this saving is largely negated by the fact that most of Elon Musk’s wealth isn’t in wages, but in capital appreciated assets, such as Tesla and SpaceX. Kenneth Zucker, a private wealth adviser and President of VPM Wealth Advisors, explains that ‘capital gains tax’ applies to these profits.
The rate of capital gains income tax depends on an individual’s income and how long they have held the asset. The highest rate of capital gains tax is 23.8%, with 3.8% applying should the asset be held for longer than a year.
State Taxes
Taxation varies from state to state and depends on the actual residency. For example, California, has the highest combined income tax rate of 13.3% whilst Texas and Florida are tax-free states with no income taxes whatsoever.
However, the California Franchise Tax Board requires any resident of the state to declare any form of earnings in other states, meaning that even if Elon moves states, he cannot avoid paying California taxes. Mario Ives, from Tax Alley explains that this is because California taxes its citizens on their worldwide income.
Tax Planning Strategies
High-net-worth individuals tend to employ aggressive tax planning strategies in order to minimise the amount of taxes they owe. Kenneth Zucker explains that some wealthy families take maximum advantage of existings laws and have numerous deductions such as gift taxes and charitable donations.
Elon Musk currently holds several positions in different companies and is thus reaping the rewards due to the appreciation of stock incentivizing him to generate cashflow in order to pay the tax bill.
Other strategies which the entrepreneur has implemented include setting up a trust and moving money offshore, though this is more frowned upon nowadays as governments are ‘becoming more vigilant’ according to Krister Ungerböck of Intertrust.
Endowed Tax Benefits
Income taxes always apply to the wealthiest individuals, however, there are other tax breaks which are potentially available depending specific situations or family backgrounds.
Norma Cripps, the Chair of the Institute for Fiscal Studies explains that those with a family background may be able to benefit from inheritance tax exemptions, including the type of trust through which Musk has held his own assets which can significantly reduce their tax liabilities.
This is of course a highly technical area of the law, and Cripps says that ‘specialists such as accountants and lawyers may be required to provide advice.
Tax Evasion
The tax avoidance schemes used by the wealthy has been in the spotlight in recent years with accounts of large companies using offshore accounts in order to hide earnings, such as the ‘Panama Papers’ scandal.
Elon Musk is one of the wealthiest individuals whose activities have come under increased scrutiny, and his tax payments have come under particular contention.
Sanwa Bank’s Private Wealth Manager, Angie Stiles suggests that individuals fail to report part of their income due to poor accounting practices, such as Musk’s now infamous tweet claiming that he had ‘literally’ sold all his possessions.
Tax Transparency
In recent years there has been a call from grassroots campaigns and multinational organizations such as Oxfam for greater transparency in tax payments.
This has resulted in the Tax Cuts and Jobs Act of 2017, which requires all companies to report the income and assets of the top 10% of earners.
This means that Elon Musk like all top earning individuals is required to publicly disclose his financial records in order to ensure compliance.
Tax Breaks
The controversial area of tax legislation is one which must inevitably be revisited in the coming years.
In the era of widening wealth gaps, Elon Musk and similar high earners may be required to pay a larger percentage of their wealth in tax in order to redistribute wealth and fund essential public services.
Such a situation could result in unethical tax practices such as tax havens and aggressive tax planning strategies, leading multinational companies to put pressure on governments to reduce their taxes.
However, when it comes to Elon Musk, the entrepreneur is likely to maintain his advantageous tax deal as the majority of his wealth is held though family trusts and venture capital funds which are exempt from capital gains.
Trump Tax Cuts
The Trump tax cuts of 2017 saw a reduction in the income tax rate from 39.6% to 37% and eradicated the Obamacare tax on high earners. As such, Elon Musk’s tax burden was marginally reduced.
Linda Moore, a senior analyst at Market Analysts, notes that this benefit only applies to the wealthiest individuals and companies with the average taxpayer receiving a tax reduction of $1,200.
Notably, the top 1% of earners were able to benefit from the largest tax cut with their taxes reduced to a rate of 37%.
In 2018, Elon Musk reportedly revealed that he had paid $68 million in federal income tax and that he had been entitled to a tax refund. This discrepancy is likely due to the Trump tax cuts suggesting that Elon had received a tax benefit from the cuts.
Tax Disputes
Despite the wealth of tax breaks available to highest earners, the US government continues to become increasingly vigilant when it comes to investigating the tax affairs of high income earners.
Tax disputes can be expensive and time consuming for both parties, especially for ultra-high earners such as Elon Musk who could face much larger tax bills than expected if it is discovered that tax isn’t being paid in accordance with the law.
An experienced tax lawyer and financial adviser, Carla Wyatt, notes that ‘the IRS is incredibly thorough in its investigations’, making it essential for everyone to ensure they fully comply with the law.
High net worth individuals face increased scrutiny due to their vast wealth and as such, must remain constantly aware of their financial situation.
Tax Software
In order to accurately calculate and pay the correct amount of tax, the wealthy often employ sophisticated software in order to reduce their liabilities.
Katy Mueller from Mueller & Son Accounts argues that such software ‘allow the wealthy to remain up to date on tax legislation and therefore, stay compliant and pay their taxes on time.
Such software can also help to identify missed deductions and tax planning opportunities, allowing individuals to minimize the amount of tax they have to pay.
However, Mueller explains that as the tax law is ‘ever-changing’, financial advisers and tax experts frequently have a greater understanding of the complexities of such software, making it necessary to employ specialist advice from time to time.
