As a CPA observing the 2012 political season, I was asked the following questions countless times. “Do rich people really pay less taxes than the rest of us?” “Does Mitt Romney really have a lower tax rate than me?” And my favorite, “How do I get Mitt Romney’s tax rate?”
Because of the Internet, anyone can easily download Mitt Romney’s 2010 and 2011 tax returns. Combing through hundreds of pages of tax returns may not be your idea of a good time, but they definitely shed light on why Mitt Romney’s tax rate is lower than many taxpayers. While you and I may not be able to take advantage of all of his tax strategies, Romney does utilize many tax-saving techniques that many of us can also employ.
Sources of Romney’s Income
One clear difference between Romney and many other working taxpayers is that he no longer has a full-time job—he’s retired. If you were brave enough to sneak a peek at Romney’s tax return, you’ll notice that line 7 asks the taxpayer to list, “wages, salaries, tips, etc.” Since Romney is retired and no longer works as an employee, he has no salary to report.
On the other hand, in 2011 Romney earned nearly $7 million in capital gains and $3.6 million in dividends, more than $2 million of which are qualified dividends. A capital gain occurs when a taxpayer sells an asset for more than he or she purchased that asset. Capital gains receive preferential tax treatment to encourage taxpayers to invest in assets including stocks, bonds, real estate and other business assets.
Qualified dividends are generally dividends on stocks held for the long-term and are taxed at a lower rate to encourage taxpayers to invest and hold stocks in companies. By investing and holding onto stocks, bonds and other investments, Romney paid a much lower tax rate than he would have paid on income he received as an employee.
How does the average Joe take advantage of this tax break? Begin investing in stocks sooner rather than later. Take a long-term approach to investing. Rather than counting on short-term gains, focus on generating long-term appreciation in the value of your portfolio and the related tax advantages that come with a long-term approach.
How did Romney get all his money to invest in the first place? By starting and building a business. Regardless of what you may think of Romney’s firm Bain Capital, the fact is that business owners are able to legally deduct many expenses from their business income that nonbusiness owners cannot.
Business owners often can deduct at least a portion of their cell phone and Internet service, the cost of operating their automobiles, the cost of buying business equipment such as new computers, office supplies—and if they have a home office, some business owners can even deduct some of the costs of running their home such as electricity, gas and rent. Because these deductions offset income earned by the business, taking business deductions is an effective way to decrease your taxes.
Business owners are also able to set up retirement plans for their businesses, which can be a very effective way to build a nest egg with preferential tax treatment. Solo 401(k) plans, SEP plans, SIMPLE IRAs and profit-sharing plans can all provide significant tax savings to business owners, while also allowing them to save for retirement.
A quick look at Romney’s 2011 itemized personal deductions (Schedule A of Form 1040) reveals a couple of very large deductions. One is for taxes he paid during the year, including state and real estate taxes. The other is his high level of charitable contributions, totaling $2.25 million for the year. This amount represents more than 16% of his 2011 adjusted-gross income, and it provided him with a huge deduction to help offset his income.
While you may not be able to donate 16% of your money to charity, giving to charity can help you support causes in which you believe and provide you with a nice tax break.
Please note this article was written before the fiscal cliff issues were resolved in late December 2012, and many of the changes being discussed could directly affect the tax strategies described above. As always, tax laws are constantly changing, so make sure you consult with a tax advisor to assist you in implementing your personal tax strategies.
Corporate Tax Network provides tax planning and preparation, bookkeeping and payroll services to small businesses in all 50 states. With a proactive approach to taxes and tax planning, they aim to help their clients retain as much profit as possible by creating a custom tax plan for their day-to-day operations. Register for a free business tax webinar today.