My friends on Facebook are pointing to Warren Buffett’s release of his tax returns (nytimes) as (1) proof that Donald Trump was lying when he said that Buffett avoids taxes, and (2) proof that Buffett, a Hillary Clinton supporter, is doing his fair share to keep the government’s cash bonfire going. Buffett reported an income of $11.6 million and taxes paid of $1.85 million. None of my friends, in celebrating this data release, questioned how the world’s third-richest person had the same income as a successful dermatologist (e.g., one who owns a laser hair removal clinic).
Let’s put this tax payment into context. Forbes says Buffett has $65 billion. Thus $1.85 million is 1/35135th of his total wealth. That’s equivalent to a millionaire paying $28 in tax, e.g., a portion of the sales tax on a new iPhone, as her entire tax for the year.
Perhaps you are thinking that Berkshire Hathaway pays corporate taxes on its income and therefore that Buffett pays additional federal taxes indirectly? Barron’s says no:
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.
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, 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.
Could Buffett be required to pay more?
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.
Apparently he could, but not if he has good friends in Washington, D.C.
Peter Schiff is on to him. He breaks it down on:
If you could dig into how his insurance/ re-insurance setup works, that might make for an interesting follow-up post.
“Let’s put this tax payment into context. Forbes says Buffett has $65 billion. Thus $1.85 million is 1/35135th of his total wealth. That’s equivalent to a millionaire paying $28 in tax, e.g., a portion of the sales tax on a new iPhone, as her entire tax for the year.”
Whoa. Does this feel unfair to you? Are you coming around to Piketty’s proposal for a tax on wealth, not just income? Are you back to feeling the Bern?
Buffett explains why Berkshire Hathaway doesn’t pay dividends, preferring to keep the cash to reinvest in existing businesses, make acquisitions, or buy back stock. It’s then up to individual shareholders to decide how much stock they want to sell each year, producing taxable capital gains. Calling this a “loophole” seems a bit strange.
For Berkshire Hathaway’s payment of taxes on profits (even when they’re not paid out as dividends), see the Taxation section of Buffett’s 1989 letter to shareholders.
Of course, the other startling thing about Trump’s 1995 tax returns is that he lost a billion dollars — a truly spectacular business failure. Matthew Yglesias describes how he made his comeback: he used a public company to take money from the public and pay off his debts.
Russil: I am not envious of Buffett. Just surprised that he has become a hero to folks who say that they want to soak the rich.
(And I am not a Piketty fan. I think the only viable long-term growth strategy is to shrink government so that it can live on a 20% consumption tax, a property tax, and an income tax at a low enough rate that people won’t change their behavior too much (15%?). Wealth tax doesn’t work in my view because it is too easy to move wealth to the most efficient countries.)
Phil, you know the difference between net worth and income. So you know your 1/35135th figure is meaningless.
Buffet’s tax returns show he pays taxes. It’s not a ton but Buffet would prefer to pay more. Trump didn’t pay taxes for 18 years. Buffet has paid tax for 60 years. Buffet’s tax returns support Hillary’s argument.
Yeah, his income is surprisingly small relative to his net worth. His personal spending is also small relative to his net worth. So why would he choose to have a higher personal income?
Your dermatologist pays herself enough to cover personal expenses and leaves the rest in the business. If her business earned $11mm in a year (well done!), and she owns the whole business, that doesn’t mean she personally paid taxes on $11mm. Let’s say her derm biz is worth $100mm and is her only asset. Let’s say she took 1.5mm as income last year and paid $500k in tax. She paid tax equivalent to 0.5% of her net worth. Is that a problem with her? with the tax code?
Buffet also points out that he gave away $2bn in the year his income was $11mm yet he still paid income tax.
Trump had NOLs totaling ~$900mm that allowed him to avoid taxes for 18 years. The loss carry-forward (and carry-back) is a rule in the tax code. So no problem. Except that generating $900mm in legitimate NOLs is real hard to do. Generally you need to have earned $1bn previously in order to have $900mm to lose. Some folks think Trump actually had 100’s of millions of debt forgiven. But his creditors didn’t cancel the debt, they sold it for pennies on the dollar to a SPV that’s not trying to collect it. That’s not allowed, of course.
Matt – ” It’s not a ton but Buffet would prefer to pay more.”
What’s stopping him?
After listening to private democrat conversations about getting the right deductions & corporate filing statuses to avoid the taxes they voted for, it’s clear that no-one knows how to avoid taxes better than the people who vote for them.
Sam – “What’s stopping him?”
The tax code stopping him from paying more than $1.85mm last year. (But you knew that, right?)
Like everyone, he pays what is required and no more.
His return says he owes $1.85mm. Let’s say he is feeling generous and encloses a check for $2001.85mm when he files his return. The IRS will send him a check for $2bn, or they’ll treat the $2bn as a credit against future taxes.
It is possible to make a donation to the Treasury Dept. They will take his $2bn. But we are talking about taxes here, not voluntary donations.
Buffet sent his (theoretical) $2bn check to the Gates Foundation instead.
Tax form allows anyone to make an additional contribution. If he wants to pay more, he can.
Last year, Warren says he made a $5m deduction from his income. Scaled to 72 years, that’s $360m of deductions so far. The actual total might be less, it might be more, but still: Not bad, Warren!
For someone who is so careful about minimising his own tax liabilities, Warren comes off as more than a touch hypocritical. Also, I assume he could change his mind about stashing his loot with the Gates Foundation and instead just pay the estate tax like a normal person when his time is up? Why not, Warren?
In conclusion: Warren, don’t be a playa hater when you the big dog playa in the pound.
“The tax code stopping him from paying more”
OK, but the same obviously holds for Trump. So why the pious howling?
Here is a link to a page on the US Treasury website with instructions and an address where you may send money to the government. I’m sure Mr. Buffet would be grateful for this information so please pass it along to him as well as any others who would like to pay more taxes.
http://fms.treas.gov/faq/moretopics_gifts.html
I think State and Federal income tax collections are currently about 15% of total personal income so we’re already on Phil’s target there. My calculations are that replacing everything else with a 20% consumption tax and 2% property tax would raise about 75% of current spending. So holding spending steady with inflation and 2% GDP growth for a decade would get us to Phil’s target. Am I off somewhere?
@Tom: Trump is not playing by the rules. His 1995 NOLs won’t hold up. He didn’t have $1bn in earnings pre-1995. His $900mm loss is offside. Buffet has vanilla tax returns. Trump has head-scratching tax returns. That’s the difference.
@Joebob: Let’s say Buffet comes to a congressional meeting and says “Please change the tax code so I, and everyone who earns $1mm+, pays more tax.” Let’s say you’re there. You say “Send your extra cash to the Treasury, dummy. Alright, who’s next?”
@Matt: How is Trump not playing by the rules? Why won’t the NOLs hold up after all these years? How is the loss “offside” and what does that even mean? How are his returns “head-scratching? How are Buffett’s vanilla? (I doubt think anyone making $11mm in income a year has “vanilla” returns). What’s the difference between “head scratching” and “vanilla” returns anyway? NOL carryforwards? It just seems a strange thing to seize on. If you have a loss why should that not count against your income and future gains? Why would you not count it?
I’m not sure where any of this is coming from other than animus toward Trump. There are a lot of reasons to dislike him but being a tax cheat does not appear to be one of them, asked on the information we have. Which simply is not enough to condemn the guy.
“based on the information we have.”
True enough, because unlike every other Presidential candidate since Nixon, Trump refuses to release his tax returns. Based on the information we do have, he lost a billion dollars in a single year, undermining his claim to business acumen. And from the fragmentary information we have, he’s paid little or no income tax at all since then.
Philip asked why Warren Buffett is admired by many progressives. I just read Atul Gawande’s Being Mortal (highly recommended). Gawande talks about Royce’s concept of loyalty to something greater than oneself – family, community, society. This is part of what makes mortality bearable: you know that the cause you serve will live on after you.
By his advocacy of higher tax rates and by his charitable giving ($2.8 billion last year), Buffett demonstrates this feeling of loyalty (call it social responsibility, solidarity, or social cohesion). Trump doesn’t appear to have this at all: his sole drive appears to be the gratification of his ego. These days he’s even attacking the Republican Party for which he’s the standard-bearer, blaming them for his looming defeat.
Fine, attack him for not releasing his returns. But the progressive stance seems to be that loss carryforwards are some kind of loophole and that Trump is a tax cheat. Like I say there’s plenty of reasons to dislike Trump, why not pick something substantive?
And as for his business acumen, losing a billion is not the acid test. It takes quite a bit of acumen to come back from that. Buffett had his major losses as well. His IBM bet is still deep in the red and then there is the Tesco fiasco, Dexter Shoes, not to mention his original investment in the Berkshire mills, to name a few. Something about an omelet comes to mind. Buffett too has lost billions but he lost them within the Berkshire corporate structure so you don’t see them flow through to his personal tax returns. But if the point is that Buffett is the finer businessman and overall human being, point conceded.
But I’m not so convinced that advocating higher tax rates on other people when the effects will fall more lightly on you (because of how you’ve structured your financial affairs and because of the sheer quantity of your wealth) demonstrates all that much loyalty or solidarity (especially compared to making a gift to the US Treasury). He made almost a million a month last year and he is one of the richest men in the world; not only that but he is also closer to death than the average person. So whatever policy he promotes won’t hurt him much at all. He could promote a 99% wealth tax on everyone and he would be just fine with his remaining 665 million or whatever if it became law. That would devastate me though and probably most of the other people who are not Warren Buffett. So I’m not feeling the social cohesion here.
For Buffett is advocating higher taxes not just on himself but also on, say, the oncologist just out of residency with zero savings, a ton of debt, but high earnings prospects. After all our definition of “rich” is not confined to billionaires like Buffett and Trump or even multi-millionaires but mainly comprises households earning in the mid to high six figures. Buffett is proposing making it harder to get rich, but if you’re already rich it won’t much matter. Indeed Buffett could very easily sell his personal investments, pay the capital gains for one year, invest the proceeds in muni bonds, quit Berkshire, and still enjoy a couple million in interest income and completely escape the high marginal tax rates he wants to impose on the oncologist. Fair?
And I’m not even convinced the money raised by any tax increase would be well spent or would produce a greater benefit to society as a whole. Indeed it might well make us worse off.
That said, I’m a huge admirer of Buffett, and my regard for Trump diminishes by the day.
@Dan There is nothing wrong with using carry-forwards and I’ve never said otherwise. If you have a loss it offsets your gains.
You think Trump’s NOLs are legit. Please explain how. A lot of CPA’s are wondering.
“Trump has head-scratching tax returns.”
The IRS has found them clear enough, haven’t they?
“Based on the information we do have”
As published in Art of the Comeback, twenty years ago or so. I believe the New York Times at the time applauded him, curious as it may seem today. It’s not like it was a big secret.
Speaking of incomprehensible tax returns, I seem to recall Warren Buffett, the least taxed man in the history of the republic, in one of his letters described the tax return of his investment vehicle as a stack of papers a foot high.
I wonder what charitable purpose his $2.8bn went to this year? (By the way, does anyone but me think trusts and foundations are THE tax loophole of American billionaires? I’ll grant that it’s fairly easy to understand.)