taxes

Tax loopholes that mainly benefit the rich

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Highlights
  • Low-income taxpayers can't afford to take advantage of the zero percent capital gains rate.
  • The tax code lets rich people deduct interest on a second home at taxpayer expense.
  • Income of most private equity fund managers is taxed at lower capital gains rates.

A tax loophole isn't illegal. It just seems that the person benefiting from the loophole often is following the letter of the tax law, but not the spirit of the law.

Similarly, there are many tax deductions that appear to provide disproportionate tax benefits to a select few.

Here are five tax breaks that fall into those categories.

Capital gains tax rate

The current 15 percent capital gains tax rate for most investors and zero percent rate for lower income taxpayers are part of the much ballyhooed George W. Bush-era tax cuts. The idea behind the lower capital gains tax is that it encourages investment, which helps create new companies that hire more people -- and we're all fat and happy thanks to this tax-subsidized investment chain. Think again.

This tax loophole is estimated by the Joint Committee on Taxation to cost the U.S. Treasury nearly $457 billion between 2011 and 2015.

And it's a huge reason why the wealthy, such as financier Warren Buffett, are able to pay substantially lower overall tax rates. Buffett's oft-repeated confession that his tax rate is lower than his secretary's sparked the latest political debate on the fairness of low tax rates on investment profits.

Ordinary taxpayers pay tax on their earnings at ordinary income tax rates up to 35 percent. The really rich, however, are different from you and me in that they tend to make most of their money via investments instead of standard paychecks -- meaning most of their money is taxed at 15 percent.

But what about the wonderful zero tax rate for investors in the 10 percent and 15 percent income tax brackets? Really? Most folks at those tax levels don't have a lot, if any, cash left over to invest after paying their bills. But by giving them the option, members of Congress felt better about voting for a tax break that benefits primarily the rich.

Home mortgage interest deduction

If you've ever bought a house, one of the first things your real estate agent and mortgage broker probably pointed out was that you get to deduct your home loan's mortgage interest on your taxes.

What they didn't tell you was that your deduction is underwritten by the vast majority of homeowners who don't get this tax break.

The home mortgage interest deduction is the largest individual taxpayer cost to the U.S. Treasury. Uncle Sam will lose an estimated $464 billion between 2011 and 2015. And that amount is racked up by just the third of American taxpayers who itemize.

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Tax loopholes aren't illegal, but they appear to provide disproportionate tax benefits to a select few.

Take the current 15 percent capital gains tax rate for most investors, and the zero percent rate for taxpayers in the lowest two tax brackets. The lower capital gains tax is supposed to encourage investment, which helps create new companies that hire more people.

But this tax loophole is estimated to cost the U.S. Treasury nearly $457 billion over four years. Ordinary taxpayers pay tax on their earnings at income tax rates up to 35 percent.

The really rich tend to make most of their money with investments instead of standard paychecks -- meaning most of their money is taxed at 15 percent.

And what about the wonderful zero tax rate for investors in the 10 and 15 percent tax brackets? Most folks at those levels don't have a lot, if any, cash left over to invest after paying their bills.

Even worse, say economists, the tax deduction probably isn't necessary. Most other industrialized nations worldwide don't offer their residents a tax break for buying a house, yet those folks buy homes. And the reality is that no one ever bought, or didn't buy, a house based on the tax law.

What the home mortgage interest deduction really does, say economists, is encourage more financially well-off individuals to buy bigger houses. The July 2011 Reason Foundation study, "Unmasking the Mortgage Interest Deduction," found that the annual average tax saving of the mortgage deduction for a taxpayer making $50,000 to $75,000 was $179, and that only about one-third in this group claim the deduction. At the upper income level, however, homeowners with incomes exceeding $200,000 get an annual tax benefit of more than $2,200, and almost three-quarters claim the deduction.

The mortgage interest deduction benefits also are geographically disproportionate. Just as high-income taxpayers get more out of it, so do metropolitan areas with high incomes, taxes and housing prices. That historically has tended to be locales in California and the Northeast.

So the next time you visit your cousin at his new house in New Jersey, make sure he thanks you for your help with his purchase.

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