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Warren Buffett is fond of saying his tax rate is lower than his secretary’s. He does not publicize his tax returns, but for the tax year 2010, he paid $6.9 million on taxable income of $39.8 million, according to partial disclosures he made in 2011.
What is astounding about those numbers is not the 17.3% tax rate, but that Buffett’s $39.8 million of taxable income is only about 0.05% of his reported net worth ($71 billion according to Forbes, which put him third on its list of the 400 wealthiest people in the world for 2015).
Proportionately, that’s like someone with an ever-expanding net worth, currently $10 million, reporting taxable income of only $5,000 and paying a federal tax bill of only $900.
So, how does he do it? Buffett’s principal holding is an economic interest of about 20% of Berkshire Hathaway. BRKA 0.6108255216208044% Berkshire Hathaway Inc. Cl B U.S. NYSE USD 166.36 1.01 0.6108255216208044% /Date(1482271244858-0600)/ Volume (Delayed 15m). 2984195 AFTER HOURS USD 166.2 -0.16 -0.09617696561673479% Volume (Delayed 15m). 118887 P/E Ratio 17.62904405141628 Market Cap 408084317511.585 Dividend Yield N/A Rev. per Employee 657257 More quote details and news » BRKA in Your Value Your Change Short position the huge conglomerate he has been building since the 1960s. It has a market value of about $350 billion. Berkshire hasn’t paid any cash dividends since 1967. Rather, the company accumulates its prodigious after-tax income ($19.9 billion in 2014) and cash flow ($32 billion in 2014) to get bigger by buying companies, lots of companies. Among its large recent acquisitions were Lubrizol, Burlington Northern Santa Fe, and a shared acquisition of H.J. Heinz. KHC -0.7159353348729792% Kraft Heinz Co. U.S. Nasdaq USD 85.98 -0.62 -0.7159353348729792% /Date(1482271200289-0600)/ Volume (Delayed 15m). 2602151 AFTER HOURS USD 86.25 0.27 0.31402651779483604% Volume (Delayed 15m). 63301 P/E Ratio 37.71052631578947 Market Cap 105415581834 Dividend Yield 2.7913468248429867% Rev. per Employee 636929 More quote details and news » KHC in Your Value Your Change Short position
The Berkshire Model is to buy companies rich in cash flow with histories of paying dividends, then cancel those dividends and retain the cash flow going forward for future acquisitions.
HOW MUCH TAX is Warren Buffett able to avoid by fixing Berkshire’s dividend at zero? The dividend yield of the Standard & Poor’s 500 is about 2%. The price/earnings ratio of the S&P 500 is about 18. Thus, for the S&P 500, approximately 30% of earnings are paid out to shareholders. These dividends are taxable at a current maximum rate of 23.8%.
If Berkshire followed the average of the S&P 500, it would have paid out about $6 billion in dividends in 2014, and Buffett’s share would have been about $1.2 billion.
At a 23.8% tax rate, that would have given Buffett a tax bill of $280 million, or about 40 times the taxes he said he actually paid in 2010.
Thus the Treasury has been getting exiguous tax revenue from one of its wealthiest citizens. Buffett is virtually immune to higher individual income-tax rates, while he promotes higher rates for other rich people, who may have a net worth a hundredth of 1% (0.01%) of his own.
Since, according to his publicly stated plans, Buffett intends to leave the bulk of his estate to charity, his estate won’t be paying much tax, either.
The Buffett Loophole and the Berkshire Model are allowing one individual to build one of the great American fortunes while avoiding individual taxes. Talk about someone not paying his share!
FOR 2014, BERKSHIRE ITSELF recorded a provision for $7.9 billion in taxes, most of which was “deferred.” In fact Berkshire, like many other companies, is able to defer much of its taxes, in its case $61 billion. This is money it acknowledges it owes the government but has yet to pay.
Deferred tax liabilities are the difference between taxes that will come due in the future and what the company owes today. Accounting rules require this difference to be recognized as a liability, but it ultimately acts as a sort of “float” that the government allows companies in the midst of an acquisition—which Berkshire almost always is.
In 2012, the year before it was acquired for $28 billion by Berkshire (and a Brazilian partner), H.J. Heinz paid more than $600 million in dividends. Those dividends were taxed and provided revenue to the U.S. Treasury. After the acquisition, the dividends stopped. Tax revenue from those dividends stopped.
In 2010, the year before it was acquired by Berkshire for $9 billion, Lubrizol paid $90 million in dividends. After the acquisition, the dividends stopped, as did tax revenue on the dividends.
In 2009, the year before it was acquired by Berkshire for $44 billion, Burlington Northern Santa Fe paid $546 million in dividends. After the acquisition, the dividends stopped, as did tax revenue on the dividends.
LAST YEAR, Berkshire entered into what became known as a “cash-rich split-off” that, according to the New York Times, might have allowed it to avoid $1 billion in taxes. Berkshire traded its stock in Procter & Gamble. PG -0.16526974383189705% Procter & Gamble Co. U.S. NYSE USD 84.57 -0.14 -0.16526974383189705% /Date(1482271299386-0600)/ Volume (Delayed 15m). 7402713 AFTER HOURS USD 84.01 -0.56 -0.6621733475227622% Volume (Delayed 15m). 82720 P/E Ratio 23.528266191853994 Market Cap 226683357796.637 Dividend Yield 3.166607544046352% Rev. per Employee 621810 More quote details and news » PG in Your Value Your Change Short position which carried a low cost basis of $336 million, for P&G’s Duracell unit plus $1.7 billion in cash, a total value of $4.7 billion. The point was to reduce capital-gains taxes that would have been due on a sale of Berkshire’s P&G stock.
It seems that Buffett and his businesses are serial deprivers of tax revenue to the U.S. Treasury. Yet that does not deter him from loudly advocating higher income tax rates for others.
However unethical the Buffett Loophole and the Berkshire Model may seem, however much they may appear to be gaming the tax code, no one has claimed they are illegal.
Now consider Section 531 of the Internal Revenue Code, which imposes a 20% tax on the accumulated but undistributed income of a corporation. And Section 532 of the Code states that the tax shall apply to “every corporation…availed of for the purpose of avoiding of the income tax with respect to its shareholders…by permitting earnings and profits to accumulate instead of being divided or distributed.”
The Buffett Loophole and the Berkshire Model provide clear examples of the purpose of Sections 531 and 532. Buffett and Berkshire are accomplishing precisely what the code is trying to prevent: shareholders getting away without paying taxes.
Enforcement of these two sections has been sporadic, subject to the judgment of the Internal Revenue Service. An official commentary on the code, Federal Tax Coordinator 2d, D-3003, states that, for enforcement of the accumulated-earnings tax, “Congress did not want the taxing authorities second-guessing the responsible managers of corporations as to whether and to what extent profits should be distributed or retained, unless the taxing authorities were in a position to prove their position was correct.”
CAN THE IRS CONTEND that Berkshire’s purchase of Duracell was not essential for its Heinz holding, for its Burlington Northern Santa Fe railroad, or for its core insurance businesses? Of course.
Can the IRS see that by looking the other way it has unreasonably feathered Buffett’s nest, allowing him to avoid paying reasonable taxes? Of course it can. It chooses not to see anything.
The relationship between the Wizard of Wall Street and our president is symbiotic. The two scratch each other’s back at the expense of the commonweal. How nice for our president, who is so eager to spread the wealth around, to have one of our richest citizens militating for higher taxes on the rich. How nice for Buffett to play to an adoring crowd of wealth-spreaders. How strange that it’s not his wealth that they are spreading around.