When the wealthy talk about tax planning, they do it in hushed tones - looking over their shoulders as if their desire to save money is cheating the government. Yet, the reality is, the IRS has no bias toward any taxpayer, regardless of income level, who takes advantages of legal methods of tax minimization.

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Unfortunately, the wealthy have many of the most common tax breaks phased out due to their high income levels. That doesn't mean legal tax planning opportunities don't exist for the affluent. With a little knowledge, creativity and forethought, people in a higher tax bracket can save more on their taxes than the average American earns each year.

Legal Strategies for Sheltering Employment Income
In his eye-opening book, "The Millionaire Next Door" (1996) , Thomas Stanley revealed that at the time, two-thirds of millionaires in the U.S. were self-employed or small-business owners. Even more people work for external companies and run small home business on the side. For those small business owners, there are massive tax-planning opportunities that are not subject to the standard income limitations.

Perhaps one of the greatest tax-reduction opportunities is the use of small business retirement plans. Under current laws, the IRS typically does not include money contributed to these plans in the profits of a business owner or self-employed individual. If an affluent taxpayer can delay excessive spending until retirement, taxation on those funds can be avoided.

Sheltering income by maximizing the use of small business healthcare and employee benefits plans is another option. By setting up health savings accounts, health reimbursement arrangements and Section 125 plans, expenses that would have been above the deduction thresholds for individual taxpayers can be paid on a pretax basis through the business.

Another legal income sheltering trick is to put offspring on the payroll of a business. Doing so provides two major benefits: FICA and federal unemployment taxes may not need to be paid if the child is a minor, and the child may be able to contribute to an IRA out of earned income. Employing a spouse garners similar results. Because there is an annual cap on the amount of FICA an individual must pay, one spouse can be compensated substantially higher than the limit. Doing so may mean that one spouse pays less into the Social Security system, but it also gives a couple the opportunity to invest privately instead of putting it in the hands of the Social Security system. (To learn more, see Payroll Deductions Pay Off.)

Strategies for Sheltering Investment Income
The Roth IRA is one of the greatest tax-planning opportunities to come along in decades. Sadly, many affluent investors are not permitted to use them because their adjusted gross incomes are too high. These investors can consider funding a non-deductible Traditional IRA. While these IRAs don't provide upfront deductions or tax-free withdrawals, the earnings can still accumulate on a tax-deferred basis over the long-term. (For more on this, see Are The Deferred Earnings Of An IRA Subject To FICA Taxes?)

Another underutilized tax reduction technique is "tax lot matching". This technique allows an investor to specify which shares of a stock or mutual fund he or she is selling, as opposed to the default IRS method of first in, first out (FIFO). Tax lot matching can provide huge savings when shares of a stock that show little gain, or even a loss, are sold instead of shares from long-term investments that show substantial gains.

Affluent investors with children have additional opportunities to shelter investment income and gains from the IRS. One of the most popular, uniform transfer gift to minors (UTMA) custodial accounts, has fallen out of the limelight since the introduction of 529 plans. While these accounts may no longer be the best college savings vehicles, they offer a unique opportunity. A parent who owns highly appreciated shares of stock can "gift" the stock to a child, have the child sell it and then report a portion of the profits at the child's substantially lower tax bracket. (To learn more, read Choosing The Right Type Of 529 Plan.)

Affluent parents and grandparents have a unique opportunity to use Section 529 plans to shift money out of their estates and shield the growth of substantial amounts from future income taxes, if used for the college expenses of any family member. Under the Internal Revenue Code, any donor can gift up to five times their annual gift exclusion limit into a Section 529 account for a child, as long as multiple gifts to the same person aren't given in the five years following. With the top estate tax bracket exceeding 50%, this can equal an estate tax savings of more than $25,000 for every $50,000 gift.

Last but not least, affluent investors who have a charitable streak should avoid donating cash as much as possible. The IRS allows investors to donate substantially appreciated securities to nonprofit organizations and take a write-off for the full amount. This saves investors the trouble of having to sell the assets themselves, pay tax on the gain and give smaller donations to the charity. In short, donate the stock and keep the cash. (To learn more, read Deducting Your Donations.)

Questionable Strategies to Avoid
As mentioned before, the IRS has no problem with affluent investors avoiding as much taxation as legally allowable. Still, no article about affluent tax-planning strategies would be complete without a warning about the practices that can land you in hot water. Even though you may overhear people bragging about these strategies at cocktails parties, be forewarned – they can lead to fines and even jail time.

The most popular of the abusive tax strategies that receives heavy IRS prosecution is offshore asset trusts. While it may sound very upper-crust to have a Swiss or Cayman Islands bank account, these accounts are illegal when used to avoid U.S. income taxes. Additionally, the various post-9/11 regulations put strict limits on how much money can be transferred offshore and for what purposes. If someone recommends that you use one of these trusts, you'll want to get second and third opinions from independent tax professionals. (For further reading, see Pros And Cons of Offshore Investing.)

The IRS also frowns on affluent investors conducting "non-arm's-length" transactions to avoid taxation. In short, all transactions among related parties should be conducted as if they were made between complete strangers. For example, parents who sell appreciated real estate to their children for half of the market value (to avoid paying tax on the gain) would not likely do this with a complete stranger. Affluent tax strategies that are not done in an arm's-length fashion are subject to IRS action.

Lastly, family limited partnerships (FLP) have become a popular way of attempting to transfer assets to the next generation, with the parents both retaining control of the assets and avoiding gift tax rules. While there are instances where such partnerships can be properly structured, they are abused enough to garner heavy scrutiny from the IRS. Using an FLP will likely put you and all of your other tax strategies under the microscope. (For more on FLPs, read Protect Your Personal Assets.)

The Bottom Line
It has been rumored that Warren Buffett, one of the world's richest men, pays less in taxes than his secretary. Whether or not that is completely true, it is not out of the realm of possibility for someone making hundreds of thousands of dollars to pay close to the same amount of taxes as someone earning just a fraction of that. The trick is to be deliberate and strategic about employing legal affluent tax planning strategies well in advance of your tax-filing deadline. Doing so will ensure that you and your family members, not the IRS, are the ultimate beneficiaries of your hard work. (For more on this, see Money Saving Year-End Tax Tips.)

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