How Billionaires Avoid Taxes

00:00 Mike: Welcome to financial planning for entrepreneurs and tech professionals. I'm your host, Mike Morton certified financial planner and charter financial counselor. And today, back to the show is our great friend Julie, welcome back. 


00:17 Julie: you. It's been a while. I'm excited to be back. 


00:20 Mike: Yes, we're so excited to have you, and today's topic was actually brought up by Julie and your husband, Dave sent me an email asking about this, and so I thought it'd be a good topic for us to discuss. So today's topic is how the billionaires are avoiding paying taxes. So you may have read this in the news that ultra high net worth folks worth hundreds of millions or billions of dollars. 


Don't seem to pay a whole lot in taxes. They're worth so much money. They must make tons of money. They're buying houses and stuff. And But they don't seem to be paying, a particularly high percentage of their salaries. Like most of us are paying, 20, 30% of income taxes and how are they avoiding paying, massive amounts of taxes. 


So you might've seen this in the wall street journal AP. And so we wanted to talk about how that works and how this might apply to you, even if you're not a gazillionaire. 


01:15 Julie: Sounds good. And yeah, I think it was like they called it the billionaire boys club or something like that. It was a fancy title. I'm sure they'll come up with some Hollywood movie about it, but interesting, nonetheless and also how did their tax returns get leaked? I don't think that was ever. Explained, but That's something else to think about. 


01:33 Mike: Good question. Yeah. And it doesn't surprise me. We're going to get into how this works and look, it's more complicated than we're going to be able to explain it. All right. There's some simple math and that's what wanted to break down is the idea, at least a big idea of how this happens or how it works. 


But of course, look they're following all the rules. They live here in the U S IRS is auditing these guys. So they're following rules is just that the rules are complicated and they have teams of people in place to help them, follow the rules appropriately and save as much as people. 


All right. So let's dive into it. At the bottom line, when I read the reports and dove into it, what it seemed to be as a simple sort of math situation. All right. And so I think that will explain a lot of how this works. So let's take a look at the current environment between borrowing and investing. 


So you can borrow money right now. Julia might have a mortgage and it's pretty low percent, right? 3% right around there. Be a plus or minus a little bit. So you could borrow a couple hundred thousand dollars and pay 3% interest. All right. Not too bad and pretty good. Now the stock market, if you're going to invest money into the market, the historical returns of stock markets are at eight to 10%. 


A year now, of course, some years they go up 20 or 30% and some years they go down 10 to 20%. But on average, if you take a 40 year, all right, not even maybe 10 years, but maybe 20, 30, 40 years, those historical returns are eight to 10%. So Julie, if I can borrow 200,000 at 3% and invest that 200,000 at eight to 10%. 


I'm literally making money year in and year 


03:28 Julie: Yes. No brainer. 


03:30 Mike: And that's the biggest thing that's going on here. All right. Is that we can borrow lots of money at a very small interest rate and keep our other money or that money, keep our other money invested in the market and be making more. 


03:43 Julie: Sorry. I was just thinking, how would that translate to a tax return though? 


03:47 Mike: Okay, we're going to get the tax returns in a minute, but I just want to go over a simple example of how assets are growing fast. 


03:54 Julie: Yeah. 


03:54 Mike: Then debts. So I'm a entrepreneur. I happened to sell my company. I got 200 million of stock. I didn't sell it. I transferred into a stock of a public company. So I'm worth 200 million of stock that I own. Okay. And this year that grows at 10%, 10% kind of year in and year out. So my net worth the amount I made, quote unquote it's on paper is $20 million. 


Okay. $20 million. So if I want to live pretty nicely, I could borrow $5 million. I could have living expenses this year of 5 million, for whatever it is that I want to do and enjoy spending 5 million this year. So my net worth just grew by 15 million. I made 20 million of unrealized paper gains. 


The bank says, sure. We'll lend you $5 million and you can spend that. So my net for this year is actually growing by $15 million. And that's how you could see that. I didn't really make any income in that simple example, I just borrowed 5 million for my living expenses. The bank said, no problem. You were at 200 million. 


We'll give you 5 million. And yet that 200 million grew . Again, my assets are outgrowing my debts. They're going faster than my debts. And therefore on paper I'm worth more. I had an increase in value. And yet I didn't have to make any income and I could spend $5 million just living the way I want. 


05:16 Julie: Which is all well and good. If you have $200 million, 


05:20 Mike: correct. That's the thing that's but that's how these got one of the, again, simplified version. Okay. The story, but that's the big thing here is how we can do this. This is called buy, borrow and die. That's the strategy here? For the billionaires buy, borrow. And die. And we'll get to, we'll get to the die part a little bit late. 


I'm sure it'd be questions like, wait, how does this actually work? Okay. But let's get back. So that's a simple example. We're going to borrow, remember our assets are growing faster than our debts. And normally I said 10% look people in this billionaires. Their net worth is growing faster than 10%. 


Amazon or Google or Facebook, these companies have been going up for 10, 20 years, faster than 10%. So these are the entrepreneurs that are in the news that people tend to talk about. 


06:06 Julie: Okay. 


Now let's see how this translates to us. Regular folk. 


06:11 Mike: Yeah. Yeah. So let's get back to your question around. All right. So how are they not paying taxes? All right. Still remember that taxes. We pay taxes on our income and realized gains capital gains. All right. So when you sell that stock in order to buy something, Hey, I want to sell some stock to purchase something. 


Then you know, the growth in that stock your input. So that's how you pay. Taxes from income from capital gains are the two major sources. So let's take a simple example. You and I, or entrepreneur professional out there make, say $300,000 in a year. We spend about a third of that in taxes, maybe 90,000. 


It's about a third of your income. And you're going to spend the other 200,000 to live your life. Got a couple of kids, got a mortgage, where to spend that money. So we spent about 30% of our income on that. All right, let's take my previous example. I'm worth 200 million. I'm going to pay myself a salary of 500,000. 


I'm going to spend in taxes about 35% of that close to a couple hundred thousand. Same as you, a little bit more than 30% in taxes. All right. But I'm going to borrow that 5 million okay. To live the way I want to live. And borrow the 5 million. And again, my net worth goes up so I can borrow that. 


No problem. I'm worth more at the end of the day. So the headlines read, Julie, Mike only pays less than 200,000 in taxes, but he's worth over $215 million. Okay. My net worth grew by 15 million and yet I only paid under 200,000 in taxes or less than 1% of how much. Or how much my worth grew this year. So less than 1% was paid in taxes. 


Whereas you paid 30% 


07:54 Julie: Yeah. Unfair. 


07:58 Mike: because I was able to borrow so much money, 


Right. Because my assets are growing significantly fast, fast, 10%. And so I borrow money to live 


08:06 Julie: you're also paying taxes on that $15 million gain. 


08:11 Mike: No, because I did not sell it. , my net worth grew by 20 million. My stock went up by 10%, but I didn't sell that stock instead. I borrowed money. 


08:21 Julie: Gotcha. All right. But I'm seeing that this is where the dye part comes in. Because at some point you're going to sell, which means At some point you're going to pay those taxes. Or. 


08:33 Mike: some point , you're going to have a lot of debt. You're going to have a lot of value. Yeah. That 200 million grew to 400 million or potentially a billion. And your debt grew from the 5 million. I borrowed to 10 million to a hundred million, 200 million that I borrowed. So yeah, you're going to have a lot of debt, but you're going to have significantly more. 


Assets. And when you die, you have to unwind all these things, right? Like you said, you have eventually have to pay. All right. But let's talk about that for a minute. 


09:05 Julie: Hold on let's back up really quick, just because you talked about you're borrowing all this money. You have to make payments on it. If you're only paying yourself a $500,000 salary, but you've taken out a $5 million loan, your monthly payment is even at minimum, a large chunk of cash. So where is that cash coming? 


09:26 Mike: First of all, if you have over say a hundred million dollars, guess what your rates are for borrowing less than 1%. 


Why? Because that bank really wants your a hundred million sitting at their bank. 


09:38 Julie: Right. 


09:39 Mike: Right. Cause they're going to make 


09:40 Julie: zero risk. 


09:41 Mike: Their stuff. They're helping you. They're part of the team, you're paying them salaries and all kinds of stuff. So they're like, sure. We'll lend you at less than 1%. 


Current rates we know are, like zero, right? So they can borrow for less than 1%. These are interest only loans. So you're only paying interest is not like your mortgage. Over 15 or 30 years, we were paying principal and mortgage and they mostly don't pay back the interest. They just let it go. 


All right. So the 5 million goes up to 5.5 million of borrowing, by the end of the year, just let that 1%, add on to the debt, because again, Hey, my net worth went up by 10, 20%. My, my debt can go up by 1%. No problem banks is okay. No problem. You want, how much more do you want to borrow? 


10:24 Julie: But at what point does the bank say? We need some money back. 


10:28 Mike: Only when you get to 30 to 50% of your net assets. So you can borrow up to, if you have a hundred million, you could borrow up to 50 million. 


10:36 Julie: Wow. Okay. 


10:37 Mike: Yeah. Now . That's true. For all of us, you can have margin, you can allow to borrow based on your stock portfolio. If you have 500,000, you could borrow up to a couple of hundred thousand. And invest that now it gets risky. If you're close to that edge, that 40%, borrowing, if I have 500,000, I borrowed 200,000. 


So my investments are now 700,000 in the market and the market goes down by 20%, we start getting in trouble. 


11:02 Julie: Yup. And that, Okay. 


so that's, I'm going to let you. Move on, because 


11:05 Mike: So same thing. 


11:07 Julie: the, my next question is going to be so for those of us who aren't $200 million in the green that we could use this strategy, but the risk is much higher for us. And, right. now where we talked about in , your most recent newsletter about bubbles and is the market in a bubble right. now and bubbles pop. 


We don't know when, but we know they pop. So That's the risk. 


11:31 Mike: Yep. And before we move on, so we've got a couple of things we need to talk about. One is when you die, , what happens then? What are the risks? How does this apply to the rest of us? Okay. But if you really want to be kicked Julie, did you know that the interest, you mentioned, the interest that you have to pay on that $5 million? 


That's actually taxed. So I told you I was paying almost to 200,000 in taxes on my 500,000 salary. Well Paying nothing because I owe so much, I could just take it off my taxes. 


12:00 Julie: To be 


12:02 Mike: just gets better. All right. So before we get to you and I, how this, how we may apply this or how we can't let's talk about the dye part. Okay. Buy borrow die. All right. Remember my net worth is growing faster than my debts. So by the time I pass away, I do have a massive estate. Even though I have a large quantity of debt as well, then it's to be unwound. 


This is where teams that people come in and I'm not going to really spend time on this because I'm not an expert. But realize that there's ways of doing the best you can to save them. All right. So in other words, the last 10 to 20 years of my life, as I look at my assets and debt, I try to start unwinding these things in very tax efficient ways. 


I start giving things away to my heirs where they're going to go. I get it out of my estate. I could pay it. Life insurance comes in here and this is very typical. Even people, 10 20 million using life insurance, not selling the assets. 


12:59 Julie: Okay. 


13:01 Mike: Okay. So I've got 20 million of stock. That's really grown. I started my own company or whatever it is, or I just had a great investments that really did well. 


I don't want to sell that and pay the tax gains. All right. I'm going to get life insurance. And when I die, I'm going to pay my estate taxes. With the life insurance. So you have to pay the premiums for the life insurance, of course. But that's a way more tax efficient manner. The reason this works in today's environment, Julia is because of the step up basis when I pass away and I've got 20 million or 200 million of assets that have grown significantly that I never sold and I never paid capital gains. 


They pass to you, Julie, and you get them at face value and you don't have to pay any taxes on those gains. 


13:48 Julie: Because I didn't, I wasn't holding them as they gained. 


13:51 Mike: That's right. This is called the step up basis at death. When you inherit something that has a game built in, you do not have to pay taxes on that gain. You get it. If it's worth 20 million today, I paid 1 million. It's worth 20 million. This is a apartment building, or it could be a stock. I paid 1 million, 20 years ago. 


Now it's worth 20 million. If I sell it before I die, I have to pay capital gains of $19 million. If I die and give it to you. You get it at 20 million and it's worth 20 million. So if you sold it the next day, you wouldn't pay anything in capital gains. So we avoid capital gains at death with the step up basis. 


And that's one major strategy for passing on wealth. 


14:36 Julie: Okay, but you can only do that upon death. You can't just gift it to your area. 


14:41 Mike: That's correct. 


14:42 Julie: While you're alive. Yeah. Okay. 


14:44 Mike: Now the gifting, of course, I've mentioned, you know, last 10 or 20 years of my life. I might be gifting things that's to avoid estate taxes. And again, they're super complicated strategies for how to do that. And then you hold onto it, until your death or pass it on again. 


So anyway, 


14:58 Julie: And how does the debt work upon death? 


15:00 Mike: the debt needs to be paid off and that's where, insurances or other things are gonna come in and pay off those debts. 


15:07 Julie: Okay. 


That's interesting. When I used to work in higher ed financial aid we always recommended to our students that they never consolidate their loans when they get married with their significant other, because student debt, when you pass away, Is eliminated unless you've consolidated with the surviving borrower. 


So just anecdotal note. 


15:30 Mike: Yeah, no. And I'll say this actually debts don't have to be paid off if there's nothing left in the estate. If you die with 500,000 of debt, but you have no money, those lenders are out of luck. You didn't have any money. It's not that doesn't as the same as your student debt, it does not pass on to an heir. 


It's just, if the estate has money, of course, the estate owes those creditors, those lenders. So how might this apply to you and me? You think we can take advantage of any of these strategies? 


15:58 Julie: On a small scale, I would think perhaps a home equity line of credit or however the risk is much higher. For us. 


16:10 Mike: So you've highlighted one, one problem that's the normal folk have is that if I don't have hundreds of millions and I'm seeing those grow. So again, if I have a couple hundred million and I borrowed 20, 30, 40 million, that's only still 10, 20% of my total net worth. So that seems pretty reasonable. 


Okay. In other words, let me translate into you and I are already doing. How are we doing it? Our mortgage. All right, you have a house worth a million, you borrow 600,000. And you're slowly paying that back. So you've got a bunch of debt, 600,000. You borrowed, I'm guessing Julie, you also have some investments in the stock market and your 401k or individual retirement accounts, a brokerage account. 


So you have a large debt and you have an investment in the stock market. So you've borrowed money and you've invested. So we're doing the same thing already. But when you start scaling it up, okay. We just don't have the capacity to take on more risk typically because we're already, maybe at that 40% ratio of borrowing versus how much you're worth. 


All right. So simple example, if we have a million dollar. Okay, nice home. And we have 750,000 of mortgage to help cover that. Okay. So we have 250,000 of equity in our seven in our $1 million home and also in our we've been working for a couple of decades, so we've got some good portfolio built up another 750,000. 


So our debt, the 750,000 of debt to maybe $2 million of total assets. We might be borrowing maybe 40% debt to asset. 


In my other examples, if I'm worth 200 million, I could borrow up to $80 million, to reach that 40%. So I'm probably not borrowing quite that much, but even if I was, if my net assets again, grow by that 10%. 


I can borrow another five, $8 million, no problem. And still stay under those thresholds. 


18:15 Julie: So one quick this all makes complete sense and. Why it's more beneficial if you are ultra-wealthy versus I want to, I don't want to say normal wealthy, average wealth, I guess. however, there might be some people who are thinking. Okay. 


I bought my house X number of years ago for, let's say $350,000. 


The market has shot up significantly since then. Maybe you bought your house right after the housing crash, right? And now your house is worth 7 50, 8 50. answer. You didn't borrow all three 50,000 when you bought it. So say you only owe 200 now. You have a much larger debt to asset ratio. 


Would it make sense then to borrow against some of your asset. 


to invest? 


19:05 Mike: So this gets into the psychology portion. All right. And most people like to not have too much debt, especially as in your example, 20 years, maybe you're getting closer to retirement age. You're almost paid off that mortgage. Many people like to not have that mortgage and not have those required payments, it feels more flexible. 


Okay. Now we're getting to the point that maybe you don't have as much flexibility in your human capital. In other words, changing jobs, taking on that new job, moving somewhere else for something Hey, we're getting towards the end. I just want to enjoy my time. So you feel like you have less flexibility in the human capital. 


And so by not having as much. Feels like more flexibility in your retirement or getting close to retirement or whatever it is for your time. I know so many stories. So this is the numbers game versus psychology. The numbers games as exactly what you said, Julie. If I can borrow it 3% and make eight to 10%, I should do that year in and year out. 


I should do that all day long, but the psychology is. I don't want the, I don't want the risk. I want the sleep at night. I don't want to have to worry about what, when it goes down 10% versus going up 20%, who knows what the averages are going to be going forward. That's what they were historically. 


So there are so many stories that people have paid off their mortgage, really aggressively pay down the mortgage. And when you finally don't have a mortgage payment just feels so good. I was speaking with someone the other day that paid off all their student debts. They had aggressively paid them down. 


And when they reached that point, ah, just felt so good. And it was wonderful. You could see the look on her face. Oh, it just felt really great. I reaction as a financial advisor oh, I wish you hadn't paid them down so aggressively and invested more in your retirement funds at the same time. You don't pay them down the line. 


So that's the psychology that most people aren't really. Willing to take on that risk. They just don't want to, and there's not nothing wrong with that. All right. Because it's your life. I want you to feel great about where you are and what's coming next. All right. But to your point, yes, that's the numbers game that you would borrow all day long at two or 3% and invest into the market. 


There's some people that can do that, that can have the psychology makeup to say, oh yeah, let's go ahead and borrow some money. And one thing I would throw out there is right now, we just had a podcast and newsletter about this. Be defensive. Now's the time for , not borrowing a ton of money investing it. 


Now's maybe not the best time for doing that, but I would be ready. I would have a, he lock ready. Potentially refinance. If you're in a situation that you can get a lower interest rate, take some money out potentially, and keep that money be ready because if the stock market goes down 20, 30, 40%, that's when it's on sale. 


Okay. And that's when you can feel more confident depending on your situation, whether you're working retirement, how you're feeling all of that, about investing more into the market. So I think back March, 2020, When it was down 30%, 20, 30%. If you had done that, of course, it's looking backwards, we never know what's going to happen. 


But if you had done that, you would have made 40, 50% on your money easily from. Even if you didn't buy at the absolute bottom just because it's come roaring back now that doesn't always happen. So I'm not suggesting to run out and do that, but in terms of being defensive and being ready, now's the time for taking a look at where you might be able to have cash reserves, borrow money, if you want, if you want to be ready for that, 


22:39 Julie: Yeah, that's great advice. 


22:41 Mike: anything else that we haven't. Covered in terms of this topic. 


22:45 Julie: No, I think you did a great job of explaining how it works, why it works and for whom it works best. 


22:56 Mike: Yeah, like we just talked about that's, in this final little segment is about how to borrow money to invest money. Unfortunately, most of us just aren't ready to bridge that gap. If I have a couple of hundred million and I'm only borrowing 20 or 30 million, I feel very comfortable borrowing. 


More, it's such a small percentage that I feel comfortable bridging the gap of a five-year downmarket. That's what I'm talking about in terms of bridging that gap, having the psychology to say no will be okay. Cause I can withstand the law of averages the more I have available. 


So yeah. Excellent Julie. really loved the question and this has been great. 


23:30 Julie: too. Same. 


23:31 Mike: All right, we'll catch you next 


23:32 Julie: right. See you later. 


23:33 Mike: Cheers. 


Thanks for joining us on financial planning for entrepreneurs. If you like, what you heard, please subscribe to and rate the podcast on Apple iTunes, Google play Spotify, or wherever you get your podcasts. You can connect with me on linkedin or mortonfinancialadvice.com. I'd love to get your feedback. If you have a comment or question, please email me at . Until next time thanks for tuning in