How Buffett will Avoid the Buffett Rule, and You Can Too

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Warren Buffet, the Sage of Omaha, has been complaining lately that his tax bill is not high enough.  He famously talked about how his cleaning lady (later changed to his secretary when the story is retold by others) pays a higher tax rate than him.  He has said that the wealthy should pay more in taxes.

As a result, the Obama administration has released what they call the Buffett Rule.  This is a new tax on those making more than a million dollars.  The trouble is that Warren Buffett did not make a million dollars last year.  In fact, he didn’t even pass the $200,000 threshold that President Obama has cited as “rich.”  He only made a salary of about $180,000.  So what gives?

The issue is that Mr. Buffett does not take a large salary.  Instead, most of his wealth is tied up in long-term capital gains in Berkshire Hathaway stock (the ones who bring you the talking gecko commercials).  This means that he pays no income taxes on his most of his wealth, despite being worth billions of dollars, since that is only a paper profit until he sells the shares.  So, unless there is a tax on wealth, he will continue to pay a lower tax rate than his cleaning lady.  (Note that the companies he owns stock in pay a fairly large 35% income tax, which affects his share prices.  He therefore is actually paying taxes on his wealth, as are all investors, which is the reason for the argument for lower capital gains taxes.  The point here is that the Buffet Rule will not cause Mr. Buffett to pay any more taxes).

But at least when he dies the wealth will be taxed as the money is inherited by his children right?  Not exactly.  You see, Mr. Buffett, like many billionaires, has created a foundation in his name and given a few billion to his foundation.  (Originally he was going to give most of his wealth to the foundation, but decided later to give the bulk to the Bill and Melinda Gates Foundation).  The foundation can then hire his children.  They can work in a big foundation-provided office, live in the foundation-provided houses, drive the foundation-provided cars, and take foundation-provided trips in foundation provided airplanes to perform “research” for the foundation.  He has been able to use his wealth to set his children, and probably his grandchildren up for life without ever paying a dime of tax on this wealth.

So, what can be learned besides the hypocrisy behind the Buffett Rule?  One can learn is that by buying stocks long-term and holding onto them, one can avoid personal income taxes almost indefinitely.  One can even avoid paying personal income taxes ever if the proceeds are given away to a qualified charity or, if wealthy enough, one sets up a foundation.  While it seems  exciting to trade stocks regularly, all you are doing is generating brokerage commissions and taxes.  To really use the tax-deferral properties of common stocks, invest for the long-term.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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