Quote:
Originally Posted by Biesterfield
Let's talk capital gains tax. True or false: It is incorrect to say that Warren Buffett pays less taxes than his secretary, since his income is disproportionately made from investments, because those investments get taxed at the corporate income tax rate (say 35%) before being taxed again at the capital gains rate (15%).
can we just clarify whether or not this is a gotcha type question first?
he almost certainly pay a higher amount than his secretary so if we are talking about him paying "less" in the sense of fewer dollars then that is almost 100% likely to be wrong.
he almost certainly pays his personal income tax at a lower average rate than his secretary and has said as much.
now that we have that out of the way we can debate the percentages. This part is much less clear as different companies pay different corporate income taxes and these taxes for the same company can vary from year to year especially in the event of present year losses or tax loss carry forwards. While Buffett invests in high cash flow companies who basically never have negative profits this is not true of all companies. Each of his investments is more likely to be taxed at multiple levels than the average investor is (at the corporate level and again at the personal level) resulting in a higher effective tax rate than what is published as his personal income tax liability.
Furthermore, Buffett is an extreme case not because of his wealth, but due to the sheer longevity of his holding periods and the fact that his wealth is diversified due to Berkshire's diversity and not due to having to turnover his personal portfolio which would trigger more taxable gains. Thus, most of his wealth is fluctuating on a mark to market basis which is a non-taxable gain.
His real tax rate could fluctuate from minuscule to through the roof depending on how you want to frame it:
If he goes through a year without selling any shares of Berkshire while Berkshire is up significantly you could very well see him pay income taxes of less than 1% of the increase in his net worth (however, he would also pay this same amount in years where he lost billions).
If he sells shares then he triggers large capital gains as his cost basis is tiny. Thus, he pay long-term capital gains taxes plus whatever his normal income tax comes out to minus deductions which probably ends up in the high teens given how much of his income would be derived from the shares he sells.
If you consider the tax Berkshire pays (which appears to be 30-31% annually) on top of his gains then you get a tax rate of .7*.80 which equals 44% (the tax rate on capital gains for the highest income bracket is actually 20% and I assume Buffett falls in this bracket).
Beyond this there should be some consideration that some of Berkshire's profits come from investments in other companies that pay taxes so those profits are getting taxed which factors into the valuations that are then reflected on Berkshire's balance sheets. This means there is an additional layer of tax that would bring this effective rate up. However, a lot of this is likely mitigated by the structural efficiency of Berkshire which surely offsets some tax liabilities.
It does appear that if he could have made the same investments as Berkshire did as an individual that he would have had a significantly lower tax liability throughout the years (due to corporate taxes for Berkshire exceeding what is available to individual investors) and have been able to achieve multiples of his current wealth.
Someone can correct me if any of this is wrong as I probably missed a key point or two somewhere.