The main strategies the wealthy use to lower taxes

Wealthy people reduce their taxes through methods that are legal but often unavailable to wage earners. The core difference is that rich households earn money in ways the tax code treats differently — capital gains instead of salary, business income instead of paychecks, and inherited assets instead of earned income. A person earning $200,000 in salary pays tax on nearly all of it. A person with $200,000 in investment gains may pay tax on only half that amount, or defer it for years.

The strategies fall into three categories: timing (when you report income), structure (what legal form your income takes), and deductions (what you can subtract). A wage earner has almost no control over timing or structure — their employer reports their salary on a W-2 form, and the IRS gets a copy automatically. A business owner or investor can often choose when to recognize income, what entity owns the asset, and which expenses to claim.

None of these methods are secret. They are written into the tax code. What makes them available mainly to the wealthy is that they require assets to invest, a business to own, or enough income that the math of setting up a structure makes sense. A person earning $40,000 a year cannot benefit from most of them.

Key Takeaways

  • Long-term capital gains — profits from selling investments held over a year — are taxed at lower rates than ordinary income, and this advantage grows with the size of the portfolio.
  • Business owners can deduct operating expenses, depreciation, and losses in ways wage earners cannot, and can choose when to take profits.
  • Wealthy households can use trusts, holding companies, and other legal structures to shift income between people or years, reducing the total tax owed.
  • Charitable donations, real estate losses, and investment losses can offset other income, but only if you have enough income and assets to make the deductions worthwhile.
  • The IRS has fewer resources to audit high-income households than it did 20 years ago, which means some strategies go unchecked longer.

Capital gains taxed at lower rates than wages

When you sell an investment for more than you paid for it, the profit is a capital gain. If you held the investment for more than one year, it is a long-term capital gain, and the federal tax rate is 0%, 15%, or 20% depending on your income level. If you held it for one year or less, it is a short-term gain, taxed as ordinary income at rates up to 37%.

This matters enormously at high income levels. A person earning $500,000 in salary pays 37% federal tax on the last dollar. A person with $500,000 in long-term capital gains pays 20% federal tax. The difference is $85,000 on that income alone. Over a lifetime of investing, the gap compounds.

Wealthy people also control the timing of gains. If you own a stock that has risen $100,000, you decide when to sell it and trigger the tax. You might wait until a year when your other income is lower, or until you have losses to offset the gain. A wage earner has no such choice — their salary is reported automatically, and the tax is withheld before they see the money.

Business owners deduct expenses wage earners cannot

A person who works for a company can deduct almost nothing. They take the standard deduction (about $14,000 for a single filer in 2024) and that is it. A business owner deducts every legitimate operating expense: office rent, equipment, salaries, travel, meals, vehicles, and much more. These deductions reduce taxable income dollar-for-dollar.

A business owner can also deduct depreciation — the decline in value of equipment and buildings over time. If you buy a $100,000 piece of machinery, you do not deduct the full cost in year one. Instead, you deduct a portion each year for five, seven, or more years, depending on the asset type. This spreads the deduction across time and can create years where your business shows a loss on paper, even though it is profitable in cash.

Business owners also control when they take profits. If your business earned $500,000 this year but you do not need the money, you can leave it in the company and pay tax on it later — or structure the business so the money is taxed at the corporate rate (21%) rather than your personal rate (up to 37%). A wage earner cannot do this. Their employer withholds tax when ready.

Trusts and entities shift income between people and years

A trust is a legal structure that holds assets on behalf of beneficiaries. A wealthy person can create a trust, transfer assets into it, and have the trust distribute income to family members in lower tax brackets. If the trust earns $100,000 and distributes it to a child with little other income, the child pays tax on it at a lower rate than the parent would have.

Similarly, a business can be structured as a corporation, partnership, S-corporation, or LLC, each with different tax treatment. An S-corporation, for example, allows the owner to pay themselves a salary (which is taxed as ordinary income) and take the rest of the profit as a distribution (which may be taxed differently). By splitting income this way, the owner can reduce the total tax owed.

These structures are legal and widely used. They require lawyers and accountants to set up and maintain, which costs money. This is why they are mainly available to people with substantial assets or income — the cost of setting up a trust or choosing a business structure makes sense only if there is enough money at stake.

Charitable donations and losses offset other income

A person who donates $50,000 to charity can deduct that amount from their taxable income, reducing the tax they owe. A person who loses $50,000 in the stock market can deduct up to $3,000 of that loss per year against other income, and carry the rest forward to future years.

These deductions are available to anyone, but they benefit the wealthy more because the wealthy have more income to offset. If you earn $50,000 a year and donate $5,000, you reduce your taxable income by 10%. If you earn $500,000 a year and donate $50,000, you reduce your taxable income by 10% — but you also have $450,000 in remaining income to absorb losses and other deductions.

Wealthy people also use tax-loss harvesting: selling investments that have lost value to lock in the loss, then when ready buying a similar investment to stay invested in the market. This lets them claim the loss without actually reducing their portfolio. A wage earner with a small brokerage account might do this too, but the benefit is small. A person with a $10 million portfolio can harvest tens of thousands in losses each year.

Real estate depreciation and 1031 exchanges

Real estate investors can deduct depreciation on buildings and improvements, even though the property may be rising in value. If you own a $1 million apartment building, you can deduct a portion of its value each year as depreciation, creating a paper loss that offsets other income. When you sell the building for $1.2 million, you pay tax on the gain — but you have already deducted years of depreciation.

A 1031 exchange lets you sell one investment property and buy another without paying tax on the gain, as long as you follow specific rules about timing and property type. You can do this repeatedly, deferring the tax indefinitely. A wage earner cannot defer income this way — they pay tax on their salary every year.

Real estate also offers deductions for mortgage interest, property taxes, repairs, and management fees. These deductions are available to any landlord, but they are most valuable to wealthy investors with large portfolios and high tax brackets.

Audit risk is lower for high-income households than it once was

The IRS has fewer auditors and investigators than it did 20 years ago, despite the growth in the number of tax returns filed. This means audit rates have fallen across the board, but the effect is most visible at the high end. A person earning $1 million a year is far more likely to be audited than a person earning $50,000 — but the audit rate for millionaires has still declined sharply.

This creates an incentive for aggressive tax planning. If the risk of being caught is low, and the potential savings are high, some wealthy people and their advisors push the boundaries of what the law allows. Some strategies are clearly legal. Others exist in gray areas where the IRS might challenge them, but the challenge may take years and the outcome is uncertain.

A person using a strategy that the IRS later disallows may owe back taxes plus penalties and interest. But if the strategy works for years before being challenged, the benefit of deferring tax may outweigh the cost of eventually paying it back.

Frequently Asked Questions

Why do capital gains get taxed less than salary?

Congress set lower capital gains rates to encourage investment and economic growth. The theory is that lower taxes on investment returns make people more likely to invest, which creates jobs and innovation. Whether this actually works is debated, but the lower rates are written into the tax code and explore to anyone with investment income, not just the wealthy.

Can I use these strategies if I am not rich?

Some of them, yes. You can harvest losses in your brokerage account, donate to charity, and deduct mortgage interest if you own a home. But most strategies require assets or income to make them worthwhile. Setting up a trust costs $1,000 to $5,000 in legal fees — it makes sense only if you have substantial assets to put in it. Similarly, the tax benefit of depreciation on a rental property is meaningful only if you own the property outright or have significant income to offset.

Is tax avoidance the same as tax evasion?

No. Tax avoidance is using legal methods to reduce your tax bill. Tax evasion is breaking the law by not reporting income or claiming false deductions. Everything described in this article is legal tax avoidance. Evasion is a crime and can result in criminal prosecution, fines, and prison time.

Do wealthy people always pay less tax than middle-class people?

Not always, but often. A person earning $200,000 in salary pays a higher tax rate than a person earning $200,000 in long-term capital gains. But a person earning $1 million in salary may pay a higher total tax than a person earning $1 million in capital gains, business income, and deductions combined. The effective tax rate — the percentage of total income paid in tax — can be lower for the wealthy, even though they pay more in absolute dollars.

Can the government close these loopholes?

Congress could change the tax code to eliminate or reduce many of these strategies. It could raise capital gains rates, limit depreciation deductions, restrict trusts, or increase IRS funding for audits. Some proposals to do these things are introduced regularly. Whether they pass depends on political will and the influence of people and industries that benefit from the current rules.