Take a Cue From the Ultra-Rich on Taxes

CHICAGO ( TheStreet) -- Whether they're hopping a private jet to St. Barts or handing over platinum credit cards at designer boutiques, the ultra-rich operate in a world apart from the average middle-class American.

Those differences are especially striking at tax time. The more money you have, the more options you have for avoiding or minimizing certain taxes.

"When you have a greater number of assets, you're more able to engage in planning," says Bruce J. Wexler, partner at the law firm Loeb & Loeb and chair of its New York trusts and estates department. For wealthy families, taxes are a year-round concern.

While affluent taxpayers may be able to afford a jet-set lifestyle, they can't escape the long arm of the Internal Revenue Service. American citizens must pay U.S. taxes on their income no matter what country it's earned in or where they live. They also must pay capital gains taxes on any profit they make from selling property, whether it's a lodge in Aspen or a penthouse in Paris.

That's why the only way to really save on taxes is to renounce U.S. citizenship. If you move to a tax haven such as the Bahamas or the Cayman Islands, you'll avoid taxes on income, capital gains, and property. Investor John Templeton, who popularized the mutual fund, took this route. But it's not one many American millionaires have emulated.

A more popular option for avoiding taxes is to spread the family wealth among numerous properties and investments. Thanks to the lower capital gains tax, it pays to draw most of your income from investments rather than salary. Warren Buffett pointed out a few years ago that his income is taxed at about 17% percent, while his receptionist is taxed at 30%.

Charitable giving also pays off more when you're rich. If someone in the 25% tax bracket donates $1,000 to their favorite charity, their actual cost is $750. But someone in the 35% bracket would have an actual cost of only $650 for the same donation.

But wealthy families' tax-reduction strategies usually focus on two taxes that don't apply to most Americans: the estate and gift taxes.

Although the estate tax was repealed under the Bush administration, it's expected to reappear next year. The main uncertainty is whether it will apply only to estates valued at more than $3.5 million or whether the ceiling will be raised to $5 million.

The main way to avoid estate taxes -- as well as taxes on gifts of more than $13,000 -- is through trusts. Such financial arrangements mark the clearest difference between wealthy and middle-class tax planning.

"If you're a high net worth individual, trusts appeal to you," Wexler says. That's because they serve two complimentary purposes. They allow rich taxpayers to put money in other people's names, reducing their taxable income, while keeping some control over the money.

"The concept of estate planning is transferring assets in a tax-efficient manner down to the younger generation," says Wexler. "A trust allows you to control the age at which someone gets access to the assets, and also protects those assets from marital issues and creditors."

There's nothing to prevent a middle-class family from setting up a trust, too, but it's usually not worthwhile unless you're looking to safeguard a significant amount of money. "The administrative costs add a layer of complication and cost," says Wexler.

-- Reported by Elizabeth Blackwell in Chicago.
Elizabeth Blackwell is a freelance writer based in Chicago. She is the author of Frommer's Chicago guidebook, and writes for the Wall Street Journal, Chicago, and other national magazines.