How Warren Buffett Avoids Paying Millions in Taxes

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In recent years, Warren Buffett's acquisitions have only gotten bigger. Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) bought out the entirety of Burlington Northern Sante Fe in 2010 for $44 billion. A year later, it bought Lubrizol for $9 billion.

It's often said Berkshire Hathaway, which persistently has plenty of cash available for new acquisitions, is too large not to buy whole companies. It makes sense -- subtracting the $20 billion Buffett likes to keep on hand for insurance reasons, Berkshire Hathaway has $28 billion on hand it could deploy tomorrow, if Buffett wanted to.

But size isn't the only reason Buffett prefers to own whole companies than shares in companies. And in fact, Berkshire Hathaway has made several 100% acquisitions throughout its history. The first one was in 1967, when it acquired National Indemnity.

So why does Buffett really buy big? It's the tax man's share.

Examining his holdings
Berkshire Hathaway currently owns a massive stake in Wells Fargo (NYSE: WFC  ) , one of the nation's largest banks. This year, Berkshire Hathaway will collect more than $580 million in dividends on its more than 483 million shares.

In the process, Berkshire Hathaway will also cut a check to the IRS worth just under $61 million -- 10.5% of dividends received from Wells Fargo.

The reason is somewhat convoluted. As a corporation, Berkshire Hathaway has to pay corporate taxes on 30% of dividends received from minority stakes like it has in Wells Fargo. With corporate tax rates at 35%, that works out to 10.5% of all dividends.

Public companies aren't the only ones that pay dividends back to Berkshire Hathaway. Its wholly owned companies -- from small See's Candies, to gigantic Burlington Northern Sante Fe -- will send their annual tributes back to Omaha.

But when the See's or BNSF dividend checks are finally cashed, Berkshire Hathaway won't have to dole out a portion to the tax man. In fact, when Berkshire Hathaway owns 80% or more of any company, dividends paid back to Berkshire Hathaway are tax-free.

Why it matters
Buffett has long preferred to buy at least 80% of companies when he can, citing the inherent tax advantages of doing so. The fact is 80% of a business can generate a substantially larger, after-tax gain for Berkshire Hathaway than 79% ownership. 

But what's truly impressive is Warren Buffett hasn't completely turned away from great stocks. Berkshire Hathaway owns several. Despite the additional tax burden at Berkshire Hathaway -- one which virtually no other investor endures -- Berkshire has easily crushed the market. Buffett not only beat the market, but he did it with an added handicap.

Knowing what we do about the tax code, we can rest assured Berkshire's future acquisitions will likely be big -- 80% or more of large, industrial companies all around the world. 

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  • Report this Comment On March 23, 2014, at 3:53 PM, luckyagain wrote:

    "How Warren Buffett Avoids Paying Millions in Taxes"

    It is all perfectly legal much like a homeowner deducting his interest on his home loan. Whether is good policy is an entirely different question.

  • Report this Comment On March 23, 2014, at 5:11 PM, TMFValueMagnet wrote:

    Luckyagain,

    I find the tax code a little out of place here. It makes little sense that a 79%-owned company should be taxed again (even at a lower rate), whereas 80% or greater ownership is exempt from corporate dividend taxes.

    Buffett's smart, though. And despite the additional hurdle, it hasn't seemed to stop him from beating the market.

  • Report this Comment On March 24, 2014, at 6:42 PM, alan0101 wrote:

    I find these stories about BRKB or APPL and their taxes ludicrous. Are we saying that these companies should volunteer to pay more taxes than they owe? How would they explain that to shareholders? Buffet is on record saying the tax code is not efficient, but the answer is to change the tax code, that would require work,thinking and collaboration from Congress and the concept of doing what is best for the average American and not the lobbyists and lawyers..so forget it!

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