People sometimes ask me a simple question: “Do very wealthy people really pay taxes at lower rates than ordinary working Americans? Sometimes they do (especially the very wealthy). But the more interesting question is how. The answer is not that billionaires have discovered a secret page of the tax code that the rest of us are forbidden to read. Much of the difference comes from something much simpler:

Wealth and income are not the same thing. Most people live on income. They earn a paycheck, taxes are withheld, and they spend what is left. Very wealthy people may live largely on assets—businesses, stocks, real estate, trusts, and investments. Those assets can increase enormously in value without necessarily producing taxable income at that moment. That distinction changes almost everything.

In 2021, ProPublica published information based on confidential IRS data concerning some of America’s wealthiest individuals. It created what it called a “true tax rate” by comparing federal income taxes paid with the increase in a person’s estimated wealth.

Using that unusual measurement, ProPublica calculated Warren Buffett’s rate at approximately 0.1%, Jeff Bezos’ at less than 1%, and Michael Bloomberg’s at approximately 1.3%. Those numbers were not their ordinary income-tax rates. They compared taxes paid with increases in wealth. But they illustrate an important point: A person’s wealth can increase by billions of dollars without those billions being treated as taxable income.

How does that happen? Here are seven of the most important ways.

1. OWN APPRECIATING ASSETS INSTEAD OF LIVING ENTIRELY ON SALARY

If you work for a living, your salary is generally taxable when you earn it. Suppose you are a successful physician, engineer, executive, or computer programmer earning $250,000 a year. That is wonderful income—but the IRS knows about it, and federal income and payroll taxes begin taking their share.

Now consider someone who owns a company. Instead of receiving another $1 million as salary, suppose the value of that person’s stock increases by $1 million. That increase in value generally is not taxable merely because the stock went up. No sale, generally no capital gain. That is one of the fundamental differences between earning money and becoming wealthier.

Jeff Bezos provides an extraordinary example. For many years, his salary from Amazon was modest compared with his enormous wealth. His fortune came primarily from owning Amazon stock as the company became vastly more valuable. The stock could rise by millions—or billions—without the increase itself being treated as current taxable income.

[A]      Then Comes the Second Trick: Borrow Instead of Sell. Suppose our wealthy business owner needs $2 million to buy a house, an airplane, or simply finance an expensive lifestyle. He could sell $2 million of appreciated stock. But selling may trigger capital-gains tax. Instead, he may be able to borrow against the stock. The bank takes the stock as collateral and lends him the money. A loan ordinarily isn’t income because it has to be repaid. So our investor may obtain $2 million in spendable cash without selling the stock and triggering the capital gain that a sale could produce.

[B]       Summary. This strategy is sometimes summarized as: Buy. Borrow. Die. Buy assets that appreciate. Borrow against them rather than selling them. Hold them until death. And that brings us to the next major advantage.

2. STOCK BUYBACKS CAN INCREASE THE VALUE OF WHAT YOU ALREADY OWN

Companies have two basic ways of returning excess cash to shareholders. One is a dividend. The company pays dividends to shareholders, and shareholders generally have taxable dividend income. Another is a stock buyback. The company purchases some of its own outstanding shares. Why does that matter?

Imagine a pizza cut into ten slices. You own two slices, so you effectively own 20% of the pizza. Now imagine the company buys back and eliminates some of the other slices. Your slices haven’t become physically larger, but they now represent a greater percentage of what remains. Stock buybacks don’t guarantee that the stock price will rise, but they can increase earnings per share and benefit shareholders who continue holding their stock.

For a wealthy shareholder, there is an important tax distinction: the shareholder who doesn’t sell generally doesn’t recognize a capital gain merely because the company repurchased somebody else’s shares. The wealth may increase without a corresponding current income-tax bill.

3. DEATH CAN MAKE DECADES OF CAPITAL GAINS DISAPPEAR

This may be the most remarkable rule of all. Suppose someone started a company decades ago and his stock originally cost him $5 million. By the time he dies, the stock is worth $200 million. That means there is $195 million of appreciation. You might assume somebody must now pay capital-gains tax on that $195 million. Not necessarily.

Under current federal law, inherited property generally receives a new tax basis based on its fair market value at the owner’s death. This is commonly called a step-up in basis.

So if the heirs inherit stock worth $200 million, their new basis generally starts around $200 million rather than the original $5 million. If they immediately sell it for approximately $200 million, there may be little or no capital gain.

Think about what just happened. The original owner enjoyed $195 million of appreciation during life. He didn’t sell the stock, so he didn’t recognize that capital gain. Then he died. His heirs received a new basis. Decades of unrealized appreciation may therefore escape capital-gains tax entirely. There may, of course, be federal estate tax to consider. But that is a different tax with its own large exemptions, deductions, planning techniques, and complicated rules.

4. DYNASTY TRUSTS CAN KEEP WEALTH IN THE FAMILY FOR GENERATIONS

The word dynasty sounds as though we should be talking about kings, queens, castles, and people wearing crowns. But dynasty trusts are very much alive in modern America. The basic idea is surprisingly simple. A wealthy family places assets into a properly designed long-term trust. Instead of giving everything outright to the children, the trust may provide benefits to children, grandchildren, and even later generations.

Why bother? Because properly structured trusts can potentially keep substantial wealth outside the taxable estates of later generations while also providing asset protection and controlling how the money is distributed. Consider a wealthy couple with $50 million.

They might transfer a substantial portion of their wealth into carefully designed irrevocable trusts. Depending upon the amounts, timing, available exemptions, and trust structure, those assets—and potentially decades of future appreciation—may avoid estate taxation in later generations. The numbers become enormous when compounded over 30, 50, or 75 years.

[A]      Small Gifts Become Big Money Too. Wealthy families also have simpler tools. Federal law allows an annual gift-tax exclusion. A person can give up to the applicable annual amount to another individual without using the person’s lifetime gift and estate tax exemption. For 2026, that annual exclusion is $19,000 per recipient. A married couple with children, spouses of children, and several grandchildren can therefore transfer substantial amounts every year. Do that for 20 or 30 years, invest the money, and the total can become impressive.

[2]       Other Methods. There are additional opportunities. For example, tuition paid directly to a qualifying school for another person generally can qualify for a separate gift-tax exclusion. Similar rules can apply to qualifying medical expenses paid directly to the provider. The lesson isn’t that everybody should create a dynasty trust. The lesson is that wealthy families plan decades ahead.

A Warning About Irrevocable Trusts. I learned the other side of this during my years practicing law. An attorney in our office once brought me a matter involving a woman whose husband had created an irrevocable trust. She had been married to him for approximately 35 years and believed that, when he died, the trust assets would be available for her during her lifetime and then pass to their children. That wasn’t what the trust said. I had the unpleasant job of explaining that the trust was irrevocable and that its terms controlled. Under the document as written, she was not entitled to the trust assets simply because she was the surviving spouse.

That experience reinforced something I told clients repeatedly: Never sign an irrevocable trust until you understand exactly what happens if relationships, finances, or family circumstances change. Tax savings are wonderful. Giving up control is not always wonderful.

5. A MAJOR BUSINESS INTEREST MAY BE VALUED AT LESS THAN ITS VALUE

Here’s another concept that initially sounds strange. Suppose a family owns a business worth $100 million. Now suppose Dad gives his daughter 10% of it. Is her interest automatically worth $10 million? Not necessarily.

Ask yourself this: Would you pay the same price for 10% of a private company if you had no control over salaries, dividends, borrowing, management, or when the company would be sold? Probably not. A minority ownership interest can sometimes be worth less, dollar for dollar, than a controlling interest. An interest in a privately held company may also be difficult to sell.

Professional appraisers may therefore apply discounts for lack of control and lack of marketability when appropriate. These discounts are not automatic, and you cannot simply pick a convenient percentage. The valuation must be defensible and supported by the facts. But with a large family business, even a legitimate 10% or 20% valuation adjustment can represent millions of dollars. This is one reason sophisticated estate planning often involves not only attorneys and accountants but also professional valuation experts.

6. CHARITABLE TRUSTS CAN COMBINE GIVING WITH TAX PLANNING

Charitable planning provides another set of opportunities. One example is a Charitable Remainder Trust, commonly called a CRT. Suppose a wealthy investor owns stock that has increased dramatically in value. Selling the stock personally could create a large capital gain. Instead, the investor may transfer the appreciated stock to a properly structured charitable remainder trust.

The trust can sell the stock and reinvest the proceeds. The donor or another beneficiary can receive payments from the trust for life or for a specified period, subject to detailed tax rules. The donor may also qualify for a partial charitable income-tax deduction, based on the value of the charitable remainder interest. Eventually—and this is the essential part—the remaining trust assets go to one or more qualified charities. The assets do not simply come back to the donor.

This can make charitable trusts attractive to people who have highly appreciated assets and genuinely want to combine philanthropy, income, diversification, and tax planning. But charitable trusts are not magic tax-erasing machines. They are highly regulated, and distributions to the income beneficiaries can themselves carry tax consequences.

7. SOMETIMES THE SIMPLEST TAX STRATEGY IS MOVING

Not every tax strategy requires a 75-page trust document. Sometimes you just need a moving truck. States tax income very differently. Some impose substantial income or capital-gains taxes. Others impose no individual state income tax at all. For someone selling hundreds of millions—or billions—of dollars of appreciated assets, changing legal residence can potentially produce enormous state-tax savings.

But merely buying a condominium in a low-tax state isn’t necessarily enough. A taxpayer who wants to change domicile must establish that the new state is truly home. States can examine where the person actually lives and other evidence of residence and intent. For an ordinary taxpayer, the difference might be a few thousand dollars. For a billionaire selling billions of dollars of stock, the difference can potentially be hundreds of millions. Same tax principle. Very different number of zeros.

THE REAL SECRET

So, what is the great secret that wealthy people know? It really isn’t a secret. The American tax system generally taxes income more readily than it taxes increases in wealth that haven’t yet been realized.

Most working Americans receive much of their economic benefit as wages or salary. The money arrives, and it is taxable. Very wealthy people may derive much of their economic benefit from asset appreciation. Their companies, stocks, and real estate can become more valuable without necessarily creating an immediate income-tax bill. They may then borrow against those assets rather than sell them. They can make lifetime gifts, use trusts, make charitable transfers, obtain legitimate valuation discounts, establish residence in lower-tax states, and ultimately pass appreciated property to heirs under rules that may provide a new basis at death.

None of this means wealthy people pay no taxes. Many pay enormous amounts in absolute dollars. Nor does it mean every strategy works for every wealthy person. It means something much simpler: Once you own substantial assets, the tax system gives you planning choices that a person living entirely on a paycheck usually doesn’t have.

That is the real dividing line. It isn’t simply rich versus poor. It is income versus wealth. And once you understand that distinction, much of what seems mysterious about how America’s wealthiest families minimize taxes begins to make sense.

 —————————————————————

Ted is a retired attorney, so he is writing only as a layperson. This article provides general information only and is not for a particular situation; it should not be construed as advice. It is provided without express or implied warranties of any kind, including but not limited to implied warranties or merchantability or fitness for a particular purpose. If you have a particular problem seek advice from a CPA, attorney, or doctor. Sorry, my attorneys made me say all that!