Tax Day 101: How some millionaires can owe no taxes

According to the latest data from the IRS, some millionaires owed no taxes in 2007.

April 15 is the day US taxpayers mail individual tax return forms to the Internal Revenue Service, along with a check for what they owe. But about a thousand millionaires owed no taxes in 2007, the most recent year for which the IRS has released data.

Nearly a thousand Americans with more than $1 million in income paid no taxes in 2007.

How's that?

It's a phenomenon that, when mentioned in another installment in this series, drew reader questions. After all, the US tax code is set up to lean hardest on people with higher incomes, and $1 million is high by any standard.

Yet 959 tax filers had that much income and were not taxed, according to latest (2007) data from the Internal Revenue Service. And, as the earlier Monitor article reported, 1,646 tax filers with incomes between $500,000 and $1 million were "nontaxable," or owed no tax that year.

So here's a closer look at why this occurs in a fraction of cases -- far fewer than 1 percent of high-income filers.

The key to the mystery is the deductions available within the maze known as the US tax code. Your income matters, but so do those deductions and credits.

Some of the big adjustments include those for taxes paid elsewhere (including for state or foreign taxes), for charitable giving, for personal medical expenses, for casualty or theft losses, and for losses on a partnership or S corporation.

For people who borrow money and use the loan to make investments, another major way to reduce tax liability is called the "investment interest expense deduction."

“Certain itemized deductions and certain exclusions from income [can] cause nontaxability by themselves," IRS economist Justin Bryan wrote last year, in an article exploring the anomaly of people with high income and no income tax. More frequently, he added, what's involved is "a combination of reasons, none of which, by itself, would result in nontaxability."

His analysis -- in an annual report on the topic mandated by the Tax Reform Act of 1976 -- includes some hard numbers on people with incomes over $200,000 who pay no taxes. In 2006, most people in this group ended up paying federal income tax equal to 15 to 25 percent of their adjusted gross income. Only 3.3 percent of these high earners paid less than 10 percent of income. But 8,252 tax filers in this income group who were not taxed at all.

You can call those deductions loopholes or call them the best parts of the tax system. (And you can wonder how many people grab large deductions through creative or fraudulent accounting.)

But for now, deductions that are perfectly legal make a big difference when it comes to taxes that people owe -- at all ends of the income spectrum.

Also in Tax Day 101:

Part 1: Top mistakes to avoid on your tax return

Part 2: Who pays no income taxes on April 15?

Part 3: How to file a tax extension form to the IRS

Part 4: How is the tax code changing under Obama?

Part 5: Are some states driving people out with high state taxes?

Part 6: How some millionaires can owe no taxes

Part 7: The tax code needs a fix – but exactly how?

Part 8: 42 excuses you can't use to avoid filing IRS forms

Part 9: OK, now it's time to plan for next April 15

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