Schafer: Making a lot of money and being rich are not the same thing

No one needs advice from a lawyer or tax accountant if they don't want to pay any federal income taxes.

Just don't have any taxable income.

That's all Amazon.com founder Jeff Bezos did 10 years ago to pay nothing in federal income taxes, earning so little that year he even claimed a $4,000 tax credit as a parent. He was already a multibillionaire, in the Baker's dozen of richest people in America that year, at least according to Forbes.

Making a lot of money and being rich are not the same thing. A person earning $1 million a year in cash will pay a lot of income taxes and, with less than careful spending, could end the year with a net worth of zero.

Somebody can get richer on paper throughout the year as their assets appreciate and still pay no federal income tax.

You would think no one needs to explain that, but thanks to a high-profile article published by the nonprofit news organization ProPublica, there seems to be some confusion about it now.

People who get really mad about how little rich people are paying in income taxes are almost certainly mad about the wrong stuff.

It would've been so much better if the ProPublica editors hadn't decided to frame it as exposing the ways rich guys "avoid" paying their share of income taxes.

It felt like a long complaint about the powerful getting out of speeding tickets on I-94 by taking the light rail train.

The article resulted from somebody giving ProPublica the tax information on thousands of Americans. After months of going through it, ProPublica focused on 25 wealthy Americans.

Besides Bezos, there are other names you know, like the investors Warren Buffett and Carl Icahn, publisher Michael Bloomberg and entrepreneur Elon Musk.

It seems clear this confidential data could have come only from inside the Internal Revenue Service, either via a hack or leaked, so instead of celebrating a journalistic scoop it feels more appropriate to lament the continuing decline of an important American institution.

The authors calculated a "true tax rate" based on an increase in estimated net worth, which is of course not the way the system really works, for Bezos or anyone else. Our house is worth roughly four times what we paid for it 30 years ago, according to an estimate from the real estate firm Zillow, but we have yet to pay a nickel in income taxes on any gain.

We have a federal tax on realized income, not a tax on asset price appreciation.

These wealthy people can hang onto every share of stock they own, generate no taxable income and still live like royalty. Tesla Inc. CEO Musk insists on not taking a salary, but he has pledged millions of Tesla shares to lenders and borrowed a lot of money, as suggested by the most recent Tesla proxy statement.

Of course, I could do the same thing. I could quit work, refinance our house and live pretty well for at least awhile tax free.

Borrowed money still must be paid back someday, though. It's just not that easy, under the American tax code, to avoid paying taxes someday on real income. What a lot of people think of as tax avoidance is mostly just tax deferral.

A conventional 401(k) account is a form of that. A chunk of every paycheck is getting pulled out before getting taxed and put away for retirement. When all that money comes back out, it's fully taxable.

That's how depreciation works on an office building, too. Investors will benefit from big tax deductions early on only to later have a "recapture" on the sale of the building. The taxes are due then.

There's a wrinkle, of course, given that the powerful real estate industry gamed the tax code. It's got a clever little swap feature that effectively lets owners trade buildings and still keep pushing back the date they have to recognize the original taxable gain and pay their taxes.

Yet wealthy taxpayers can't defer a day of reckoning forever. If the IRS doesn't catch up with them, the Grim Reaper will. And if advocates for taxing wealthier people want to work for change, estate taxes would be one place to start.

The 2017 tax reform legislation enacted by Republicans in Congress created a much larger exemption from federal estate taxes. That has meant a lot more high-value estates don't get taxed at all.

The exemption adjusts up a little each year, and for 2021 it's $11.7 million, doubling to $23.4 million for a married couple.

This big exemption is set to expire after 2025, but by then people with that kind of wealth who are paying attention will have already taken advantage of the big exemption by shuffling their assets into some form of trust.

There's another quirky feature of American tax law that happens when a taxpayer dies, too, and that's called a step-up in basis. That means the asset is transferred to heirs at its current value. That becomes the new number to use when it comes time to calculate a taxable gain on any sale.

Stock that Dad bought for $1,000 years ago might be worth $1 million when he passes. That's $999,000 of taxable gain that's never going to be taxed.

Eliminating the stepped-up basis provision on seven-figure gains is one of the policy ideas of the Biden administration, along with raising the capital gains tax rate.

But there have been proposals that go well beyond these ideas, including something called the Ultra-Millionaire Tax Act. It would create a flat wealth tax on households and trusts worth at least $50 million, whether or not they sold any assets or collected any distributions like dividends.

That Ultra-Millionaire tax wouldn't apply to my household — regrettably — but it's not an idea I'd support anyway. It should still matter that the taxpayer first has to make the money before the feds can tax it.