Now You Can Avoid Taxes Like The Rich And Famous

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This is the time of year when legal ways to avoid paying income tax are top of mind. Income taxes are levied on interest from bonds and bank deposits, as well as on preferred dividends and the sale of investments for a gain. Qualified dividends and long-term capital gains get a lower rate. Even if you receive cash from your fund and invest it right back, you owe the taxman.

The second approach is to defer tax payments as much as possible, allowing money to compound for longer. It is a crucial reason why the highest-income households often pay less tax than middle-class ones, according to the Tax Policy Center.

To invest in the S⁘P 500, for example, the rich might eschew mutual funds and use direct indexing—that is, owning the stocks in the index individually so the underperforming ones can be disposed of even if the market does well. Parametric Portfolio Associates pioneered this strategy in the 1990s.

Still, stocks tend to go up, so eventually there are no losers to sell. For a few years now, quantitative-investment shops such as AQR Capital Management and Quantinno Capital Management have offered better, more complex products that combine long and short bets on stocks.

Traditionally, it only made sense to dabble in such products if you had savings in the many millions of dollars. But tax-optimizing solutions are booming as a wave of innovations reduce barriers to entry.

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