Warren Buffett’s taxes
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.
Full post, including comments
