The Millionaire Next Door

Part 2 of 3: The Millionaire Next Door. . . Swiss? Cheese only.

Why is it that most of the millionaire next door types do not cheat on their taxes?  One of the reasons is that on average they only pay the equivalent of 2.1% of their net worth in income tax each year.  From The Millionaire Next Door that is $79,000 in tax and a net worth of $3.7 million [income: $247,000].  Even those millionaires profiled in The Millionaire Mind who had a much higher income, about $750,000, and a net worth of over $9 million, paid the equivalent of just over 3.0% in federal tax. So, why would they risk going to jail for tax evasion and fraud when they pay such a small percentage of their wealth each year. Note that The Millionaire Mind national sample contained a higher percentage of highly compensated executives and professionals than did the sample in The Millionaire Next Door that had a much larger percentage of business owners.

There are people in this country who earn a million or more dollars a year who don’t have even $1 million in investments.  Thus, they often pay the equivalent of 30, 40 or even 50% of their net worth each year in taxes. Is it any wonder that some of these people are looking for (tax advantaged) service offerings? And not all of these services are legal.

What about the super rich in America; you know, the Forbes 400 wealthiest Americans? How much tax do they pay?  William P. Barett answered this question in an article he wrote for Forbes.  He contrasted the average annual federal income tax paid by the top 400 taxpayers in America, $39 million, with the average net worth of the Forbes 400, $3 billion (note: these two lists are not exactly identical, but close).  “. . . evidence is that the very rich forfeit barely [the equivalent of] 1.0 percent of their net worth to the U.S. Treasury every year.” He asked, “How do these super rich get away with paying so little?” His answer should be read by anyone even thinking about “going Swiss.”  “Not, evidently, from exotic tax shelters, but from a simple and long-standing rule of tax law that you don’t have to pay taxes on unrealized gain.  Start a company, watch its value grow, hold on to most of your shares, avoid dividends-that’s one way to accumulate a huge net worth without ever having to report your good fortune on a form 1040.” 

I once interviewed an extraordinary entrepreneur with a net worth in the mid eight figures who had been solicited many times by marketers of tax advantaged, offshore deals.  Some of these proposals seemed attractive and well conceived even to this seasoned businessman. But he never “went Swiss.”  What he did do is have a tax attorney specializing and well versed in offshore investments examine the proposals. Apparently, the attorney, a partner in a major league Chicago-based law firm, had a wonderful sense of humor.  His pro forma response after reviewing a variety of these proposals was, “Go ahead with the deal, Jack.  Not to worry.  I promise to get you out of jail within 20 years!” So, for the cost of only 2 or 3 hours legal time, this decamillionaire never jeopardized his reputation or his freedom. Jack told me repeatedly that in such cases it is much cheaper, yet much more productive to seek the advice of a well-seasoned tax expert who does not have to do countless hours of research before he gives you an opinion.

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