Big Paychecks, Tiny Tax Burdens: How 21,000 Wealthy Americans Avoided Paying Income Tax

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The richest woman in Wisconsin, Diane Hendricks, is worth an estimated $2.8 billion, but she did not pay a dime in state income tax in 2010, the Milwaukee Journal-Sentinel first reported.

Because of a change in how her company, ABC Supply Inc., the country's largest distributor of roofing, windows and siding, is structured, Hendricks reduced her personal state income tax burden from $2.3 million in 2009 to zero in 2010, according to  records the state Department of Revenue released to the Journal-Sentinel.

While a tweak in ABC's corporate structure allowed its CEO to get out of state income taxes, a complex web of deductions and exemptions in the federal tax code have allowed more than 20,000 wealthy tax filers get off the hook on paying federal income taxes.

A recent IRS report showed that 20,752 households that reported earning more than $200,000 in 2009 paid no federal income taxes. About 1,500 of those tax-free Americans were millionaires.

So how does someone in the top 3 percent of America's income earners finagle their income tax burden down to zero? For the majority of them, it's all about donating to charity, investing in local and state governments, earning money overseas and writing off doctor bills.

In Hendricks' Wisconsin case, ABC Supply switched from an  "S" corporation, which passes all of its profits and losses through its owner to be taxed under personal income, to a "C" corporation, which stands independently of its owner and whose income is subject to corporate taxes.

Scott Bianchini, ABC tax director, told the Journal-Sentinel that the switch was a "substantial part" of why Hendricks had no state income tax liability. Bianchini noted that while Hendricks' tax burden was minuscule this year, the billionaire has paid more than $10 million in taxes since 2005.

On the federal level, the nearly 21,000 high-income earners who aren't paying federal income tax represent only one half of one percent of the 4 million tax filers that make up the top 3 percent.

They account for an even smaller fraction of the 59 million tax filers who did not pay income tax in 2009. The vast majority - 56 million - of the people who skipped out on these income taxes earned less than $50,000 per year.

"It's tiny," Williams said of number of wealthy Americans who are income tax-free. "But these are the ones people get upset about."

In 1969, Congress was so up in arms about a mere 155 individuals who earned more than $200,000 and paid no income tax that it passed the Alternative Minimum Tax, which aims to prevent wealthy people from claiming too many tax exemptions and deductions.

More than 40 years after the AMT went into effect, the number of wealthy, income-tax-free individuals has ballooned to 133 times as many as the 155 that inspired the new tax.

In the 2012 battle for the White House, President Obama has made taxing these wealthy Americans a cornerstone of his re-election campaign.

Under Obama's tax plan, the Bush tax cuts would expire, raising taxes for married couples earning more than $212,300 by 3 percentage points. Obama also plans to enact the "Buffett Rule," which creates a minimum tax rate of 30 percent for millionaires.

Mitt Romney takes a virtually opposite approach to tax reform for the wealthy.

His plan not only extends the Bush tax cuts, but further reduces tax rates at all income levels by 20 percent, which puts the tax rate for those making more than $200,000 at about 28 percent. Romney ardently opposes instituting a minimum tax for millionaires, such as the Buffett Rule.

Under Obama's plan, the top 1 percent of income earners would see their taxes go up about 5 percent. Under Romney's plan, they would go down by nearly 8 percent, according to an analysis by the Tax Policy Center.

And as for the 21,000 wealthy Americans who currently pay no income tax, Williams said, "Under Obama's plan, these people would almost certainly pay more. Under Romney's, they will almost certainly pay less."