Word of The Day—Unearned Income—How the Wealthy Avoid Paying Taxes

The Rich and The Not-Rich

In my previous post on “Earned” vs. “Unearned Income”, I  concluded that the IRS keeps Americans at the bottom and the middle of the income scale from achieving their “American Dreams” by use of “limits” on contributions, and “carry over deductions” .

As proof,  I’m going to show about two examples of IRS tax credits for charitable giving that serve to keep the Not-Wealthy down.

Then I’ll reveal how the wealthy avoid paying taxes on their unearned incomes. Because, in actuality, today there are only two social classes left in the U.S. – The Rich and The Not-Rich.

The Not-Rich are workers: the Rich are investors and inheritors.

I will show that workers, including self-employed professionals and small busines owners, earn lower incomes, while being taxed at significantly higher tax rates on their earnings than investors.

Why? Because the IRS limits the amounts that workers can use their”earned” or “unearned income” to obtain tax credits (i.e., deductions from gross income) on their taxes.

Meanwhile, IRS tax shelters on “unearned income” (i.e,. investments and inhertiances) by the rich are making them even richer.

Ways The IRS Holds the Not-Wealthy Down

The IRS allows those who make “earned income” only very small portion of the the huge amounts of untaxed income granted to wealthier taxpayers who make “unearned income” from their inheritances and investments.

The IRS calls tax loopholes for the not-wealthy “Deductions” or “Credits”.  “Earned income” ensures that workers will rarely be able to progress up the ladder to become wealthy after they are taxed. Here’s why:

Read some of the instructions in IRS manuals or on its web site. You’ll see the word “LIMITS”.

Like traffic signs they’ll blare at you! You’ll also see the phrase “CARRY OVER” combined with this word “LIMITS“.

I first became aware of limits on tax credits for middle class earned-income workers when I got a 20 percent homeowners’ credit for my first-time mortgage on a condo.

Every tax year there would be a limit on how much money I could claim credits for. Every year I had to carry over money until the next tax year. Over ten years of payments, I never even got close to getting 20 percent deductions on my taxes!

Example One – For the Poor – The Cares Acts of 2020 & 2021

The Cares Act of 2021 says that whether or not we itemize our expenses on IRS Schedule A, we can give cash (and that’s cash only) to charitable donations that are 501(c)3 non-profit organizations, and we can get a deduction right at the top of our 1040 tax form’s adjusted gross income.

These Cares Acts appear to have no matching amount of “earned income” required to offset the amount that a taxpayer claims credit from giving to charity. This is great for lower income taxpayers as well as those recipients who depend upon charities for support of them and their families..

But of course, there is an IRS limit of $300 per individuals’ tax return in 2021!

Moreover, IRS Schedule A itemizers and corporations get a lot more leeway to over pay up to 100% of their income the first year. After that, they can carry forward some of their initial charitable donation over five years and get credit for each year—even though the Acts expire in 2022.

Recently though there has been talk about renewing the Cares Acts in future years. And for charities and very poor people, this is a good thing, especially if the limits are raised in the future.

However, the other hand, non-itemizers of IRS Schedule A get severe penalties if they claim charitable cash donations of over their $300 limit.

I quote this online article:  …”New legislation also increases penalties for non-itemizers who overstate the value of charitable gifts…you may be assessed a penalty of 50% of your total deduction amount.”

And here folks, with this draconaian 50% penalty is just one insulting example of how the IRS looks down on lower income workers and panders to wealthier ones. Wealthy individuals and corporations are getting a bigger break, while non-itemizers who don’t earn enough to fill out Schedule A are held down with lower limits and higher penalties.

No five-year carry-over priveleges for the non-itemizer lower income groups—bad, dishonest people, as they must be to warrant such a huge penalty. As if we all didn’t know who really cheats on their income taxes…

Example Two – For the Middle Class – QCD (Qualified Charitable Distributions)

Retirees and others who only earn “investment,” i.e., unearned income will be able to get tax credits under the Cares Acts without having to have made earned income 2021. And that’s very important for for those on Social Security and Pensions.

However, there is another option for retirees to donate way more cash to charities in exchange for tax credits. This loophole is found in the Pension Protection Acts of 2006 (QCD) Qualified Charitable Distributions”.

Used properly, signing up for a QCD can mean up to no taxes on taxpayers’ RMDs (Required Minimum Deductions) from their qualified retirement plans need be withdrawn each tax year.

In fact, QCD donations to quilified charities are omitted from their tax forms altogether.

Use of QCD can result in several kinds of tax benefits, but the taxpayer must take care to follow the rules closely to make this kind of charitable distribution. See this article from Kiplinger for more.

QCD is a much bigger tax credit  than the Cares Act $300. Amounts to charities can range up to a mamixmum of $100 thousand dollars in income. But there is a hitch.

Only those retirees who are 70 1/2 years old or older can opt to make QCD distributions from their retirement investments to give money to charities.

This is how the IRS operates to separate the American people into income classes at tax time and treats some much better than others. The QCD program is clearly aimed at wealthier retirees who must pay RMDs.

A huge swatch of retirees are being left behind in the gap between Social Security check earners at the bottom, and those workers who have additional investment incomes to retire on.

How Do the Rich Get Richer?

Meanwhile, what about those who are giving to charities in amounts well over $100,000 each year? How do they get out of paying their fair share of taxes?

Answer. The rich do not pay taxes on their investment income because capital gains taxes are assessed only when the rich sell their assets. The rich simply don’t sell their investments (or they hide them in in offshore accounts) and there is no tax.

Those who live off loans and large amounts of investments (derivatives, MBO, CDOs, etc.),  do not need to sell their assets: as Tony Zhang, speaker at wealth seminars asserts, the rich buy assets, they do not sell them.

The rich accumulate wealth year after year via the magic of compounding. They spend some for charitable distributions and/or for politcal contributions, and then hand their fortunes on down to their heirs.

According to ProPublica, some of the “ultawealthy” are now even able to take advantage of Roth IRAs to avoid paying taxes, and the Senate Finance Chair is now investigating them.

This is why progessives in Congress want to tax the rich on their “unearned income” every year regardless of what they bought or sold. Progressives claim that even 2 percent tax would be enought to pay for federal government’s expenses.

However, unless the IRS also takes its limits and penalties off of lower and middle-class income earners’ backs, any tax on the rich will not be enough to stop the super rich and the wealthy from still accumulating massive unearned income.

Even a flat tax of 15% on corporations operating in developed countries proposed at the G7 meeting this year is not going to  halt the zooming income inequality that’s growing by leaps and bounds, both here in our country and in other developed nations.


NOTE: for details about IRS taxation of Retirement Investment plans such as pensions, Traditional and Roth IRA’s, 401(k) and 403(b) employer plans, see Jim Blankenship’s An IRA Owner’s Manual, 3rd edition 2020, available on Amazon.