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Wednesday, April 18, 2012

The Buffet Tax: What Am I Missing?

It seems like every day, I’m hearing and seeing more about the ‘Buffet tax’, where Warren Buffet (who I like and admire) apparently complained that he was in a lower tax bracket than his secretary, primarily due to dividends and capital gains. Now, my initial reaction was to suggest respectfully that Mr. Buffet could simply donate the amount he desired to the US Treasury, if he felt it was an efficient use of his capital. Then one of my business partners, Matthew Teetor, pointed out that dividends are already taxed at a rate well over the highest individual rate: a dividend dollar has already been taxed once. Here’s how it works:

Dividends are paid from a corporation’s accumulated earnings and profits, which are subject to corporate income taxes. So a corporation has to pay taxes on its profits and then the shareholders pay taxes on the dividends. Accordingly, dividends are double-taxed. So, suppose I own a corporation, let’s call it Hathshire Breakaway. I’m the chairman of Hathshire Breakaway, but I’m a capitalist, so I work for $1 a year. Hathshire does well, and makes $96,700,000. On $96,700,000 the corporate income taxes are $33,845,000. (I’m only doing federal taxes; there will probably be state taxes as well; if Hathshire was in Nebraska, for example, most of the income would be taxed at 7.81%). So, after taxes, Hathshire has about $62,855,000. I’m the owner, so I pay all of the income out in dividends to the shareholder: me.

I now have $62,855,000 of income, all qualified dividends. Ignoring state taxes (Nebraska, for example, does tax dividends); I pay about $9,428,000 of federal income taxes, slightly less than 15%. I write my $9,428,000 check (I already wrote the $33,845,000 check on March 15). My secretary is sitting at her desk, upset. I ask her what’s wrong, and she tells me that she’s in the 25% bracket. At first, I feel bad for her, after all, I paid over nine million bucks in taxes, but at a lower rate. But then ask ‘What was I thinking? Between Hathshire Breakaway and the shareholder, we paid $43,273,250 of taxes on $96,700,000 of corporate income. By my calculations, that’s a 44.75% rate! (Ignoring state taxes).

So, dividends are taxed at a 15% rate, after the corporate profits are taxed at a 35% rate. So I’ll pose another idea to Mr. Buffet: You can pay ordinary rates on dividends, if we eliminate the corporate income tax. Then you can feel good about yourself, and save several million bucks of taxes.

Incidentally, if the Bush Tax Cuts expire, as they are scheduled to do, and the Health Care Bill remains constitutional, then on January 1, 2013, dividends could be taxed as high as 43.4%. Using my previous example, the tax on dividends for me as an individual would now be about $24,700,000, plus a UIMC (‘Unearned Income Medicare Contribution’) or about $2,363,000. Total taxes on my income (the corporate profits and dividends paid out) are now about $60,908,000. That looks like a rate of about 63%. Perhaps that tax rate might quiet the objectors.

Leon

PS: Just for fun, the number I used (the $62,855,000) was Warren Buffet’s income. By the way, Berkshire Hathaway does not pay a dividend; it uses its excess cash to buy back shares, which is a tax-free way of accreting shareholder wealth. Any aspersion on Mr. Buffet’s financial savvy is unintended.