Originally published on Forbes.com.
The current Presidential campaign is turning into tax blogger heaven as fairly arcane tax matters seem to be almost as salacious as locker room talk.
All About Carryovers
First, there is Donald Trump’s net operating loss carryover in the $900 million range, which for debate purposes was rounded up to a billion. Then there is Hillary Clinton’s (actually Bill’s) capital loss carryover in the $700,000 neighborhood. I seem to be the only one who has noted Mike Pence’s 2006 “at-risk” carryover of $673,797 from Kiel Brothers, a chain of gasoline and cigarette “stop and go” stores. And now we hear from Warren Buffett who likely has charitable carryovers approaching $10 billion, not that they will do him any good.
Buffett Comes Up In The Debate
Warren Buffett’s ears must have been burning Sunday night as he was mentioned three times in the debate. First by Trump:
Now, the taxes are a very simple thing. As soon as I have — first of all, I pay hundreds of millions of dollars in taxes. Many of her friends took bigger deductions. Warren Buffett took a massive deduction.
And then by Clinton
And, yes, when I was a senator, I did vote to close corporate loopholes. I voted to close, I think, one of the loopholes he (referring to Trump) took advantage of when he claimed a billion-dollar loss that enabled him to avoid paying taxes.
I want to have a tax on people who are making a million dollars. It’s called the Buffett rule. Yes, Warren Buffett is the one who’s gone out and said somebody like him should not be paying a lower tax rate than his secretary. I want to have a surcharge on incomes above $5 million.
The loophole Hillary Clinton is referring to came out of the Supreme Court Gitlitz decision. I’m skeptical that Trump took advantage of Gitlitz. The loophole would have benefited Mike Pence, whose “at-risk” carryover from the cigarettes and gasoline went up in smoke. Pence also voted for the act that closed the loophole, probably costing himself around $100,000. whether he knew it or not.
Trump was up again with:
But they really want the carried interest provision, which I believe Hillary’s leaving. Very interesting why she’s leaving carried interest.
But I will tell you that, number one, I pay tremendous numbers of taxes. I absolutely used it. And so did Warren Buffett and so did George Soros and so did many of the other people that Hillary is getting money from.
It appears that the “it” that Trump is referring to is “carried interest”, which as far as I can tell has not been used by Warren Buffett. (I need to disclose here that a large portion of my unimpressive net worth is in Berkshire Hathaway stock) I have seen commentary that Buffett’s practice of taking $100,000 salary from BH is comparable to carried interest, but given the size of his stake, he is doing a lot more for his fellow shareholders than he is for himself by keeping his salary low. Don’t tell him, but I wouldn’t object if the old fellow asked for a raise, but really, you don’t need to bring it up.
Buffett Discloses Some Tax Numbers
Warren Buffett responded yesterday with a press release that lays out key numbers from his return.
My 2015 return shows adjusted gross income of $11,563,931. My deductions totaled $5,477,694, of which allowable charitable contributions were $3,469,179. All but $36,037 of the remainder was for state income taxes.
The total charitable contributions I made during the year were $2,858,057,970, of which more than $2.85 billion were not taken as deductions and never will be. Tax law properly limits charitable deductions.
My federal income tax for the year was $1,845,557. Returns for previous years are of a similar nature in respect to contributions, deductions and tax rates.
Some Slick Tax Planning By Buffett
John R. Repetti of Citrin Cooperman gave me a nice analysis of the strategy Buffett is using.
Had Mr. Buffett sold the shares of Berkshire Hathaway and donated the net proceeds instead of the stock, he would have paid federal tax at a 20% rate or $560 million on a gain of $2.8 billion, and the charity would have received much less; $2.24 Billion. The tax planning strategy of donating appreciated property to charities has been popular for decades. It affords a greater donation to the charity, tax savings to the donor, and the great satisfaction of supporting charitable causes.
Mr. Buffett’s tax planning is simple and brilliant. Most of his net worth is tied to a company does not pay dividends (qualified or unqualified). His salary has been $100K per year forever. When he does require personal capital, he sells appreciated stock, and pays tax at the reduced capital gains rate. Since he has always been a huge contributor to charities that he supports, he also gets to deduct thirty percent of his charitable contribution base.
This is not the first time that Buffett has put out enough numbers to allow the construction of a pro forma return. Back in 2011, I was able to come up with a way to tweak the strategy that Mr. Repetti lays out, but apparently, Mr. Buffett’s advisers were not paying attention.
Mr. Buffett’s enormous charitable carryover will not do him any good, because charitable carryovers expire after five years and even at $4 million a year, it would take him hundreds of years to use up the carryover from just 2015.
Some Perspective On Carryovers
That should put some perspective on carryovers. Trump’s net operation loss carryover is as good as it gets. It can be used against any taxable income in the future and lasts for fifteen years. The Clinton capital loss carryover, except for a measly $3,000 per year, can only be used against future capital gains. Mike Pence’s “at-risk” carryover would have helped him if Kiel Brothers had turned around, but instead, it perished with the company. Charitable carryovers are a good deal for most people that have them. It takes somebody whose charitable contributions are quite larger relative to income to have them expire.
Flow-Through Versus Publicly Held Company
In some ways, it is really not fair to compare Trump’s return (or the fragments we have) to Warren Buffett’s. At least till the nineties, Trump used flow-through entities that hit his individual return. Berkshire Hathaway is a black box on Buffett’s return producing gains when he sells stock and charitable contributions when he gives it away. To get a little more apples to apples, we might want to peek inside the black box just a bit.
At least superficially, Trump’s method appears to be buying things using a lot of debt, which automatically go up in value, because now they have his name associated with them. He loves depreciation as he mentioned in the debate.
No, but I pay tax, and I pay federal tax, too. But I have a write-off, a lot of it’s depreciation, which is a wonderful charge. I love depreciation.
If you buy property with debt, depreciation deductions are funded by other people’s money requiring no cash outlay. Since Trump seems to believe that his property will ultimately only go up, depreciation has nothing real to it. That is why it is such a “wonderful charge”.
What Does Buffett Think About Depreciation?
As it happens Berkshire Hathaway’s book depreciation and amortization (amortization is essentially the depreciation of intangible assets) has been over $7 billion, the last two years. For context, Trump’s net worth is pegged at $3.7 billion, which is a bit more than 1% of Berkshire Hathaway’s market capitalization. So Berkshire Hathaway writes off about twice Trump’s net worth every year. On the other hand, purchases of property and equipment came to over $16 billion in 2015 and $15 billion in 2014. This is why Warren Buffett has a more nuanced relationship with depreciation than Donald Trump does.
Warren Buffett manages Berkshire Hathaway to maximize “intrinsic value”. “Intrinsic value”, by my definition, is what a company would be worth if the equity markets did not behave like somebody with bipolar disorder who is taking the wrong medication.A true believer in the free market always working optimally would probably expect that intrinsic value would be the mean around which a stock price would fluctuate. Regardless, sticking just to depreciation, here is what Buffett has to say in his report to me and the rest of the shareholders.
Buffett suggests that some of the amortization charges do not reflect a real costs, but when it comes to depreciation, it is a different story.
Depreciation charges are a more complicated subject but are almost always true cost. ……….. When CEO’s or investment bankers tout pre-depreciation figures such as EBITDA as a valuation guide, watch their noses lengthen while they speak.
A Look Inside Buffett’s Black Box
But what about depreciation as a tax charge? Remember that Buffett, unlike most CEOs is not managing for reported earnings, but that is what we have to work within the financial statements. And it is in the financial statements is where we can get information about how this relates to BH’s taxes.
In 2015 BH’s income before taxes was $34.946 billion. The provision for income taxes (the amount deducted in computing reported earnings) was $10.532 billion. The notes explain why that is different from the $12.231 billion that you would expect if BH’s tax were at 35%. More than half of the difference is because corporations get a break on dividends from other corporations.
Here is the part that I find really interesting though. Not in the tax notes, but in the supplemental cash flow information, we learn that BH actually only paid $4.535 billion in taxes total. The relationship between the hypothetical 35%, the provision and the amount actually paid is consistent with the two prior years. You will also find that that relationship is pretty common in public companies if you spend some time with my friend EDGAR.
Don’t Try This Answer On The CPA Exam
This seems like it might be some sort of dark conspiracy, but it is really not. Back in the day, companies used to game their tax provision in order to smooth earnings. The really smart people at FASB were on to them. One of the things they came up with was the concept of deferred taxes.
The idea is that if you deduct something from your tax return before you deduct it from your book income, that is going to turn around on you someday. So you kind of make up another tax return that shows what the tax would be if book and tax deductions were the same. That is the tax that goes on the income statement. The difference runs through the balance sheet in deferred taxes, a liability account.
I have to say that the explanation above is a gross oversimplification, but I believe the essence is correct. At any rate, if you bought a lot of equipment and depreciated it at one rate for tax and another for book and that was your only difference, after it was all fully depreciated, your deferred tax liability would be zeroed out.
But BH is different from that simple example. Year in and year out, it places in service more equipment (at least on a dollar basis) than it retires. So the deferred tax liability keeps growing and growing. between 2014 and 2015, it went from $61.936 billion to $63.199 billion. The amount of that related to plant, property and equipment went from $34.618 billion to $36.770 billion.
So Donald Trump loves tax depreciation, but Warren Buffett must at least like it a little. Because tax depreciation is faster than book depreciation, he has an extra $36.770 billion to do smart things with to make himself richer and keep me out of poverty.
Much Ado About A Billion
So I’m beginning to think that too much is being made of Trump’s personal net operating loss carryover. It only looks big, because Trump decided to do things with privately-held flow-through entities rather than going public. In its 2015 10-K Facebook discloses
Cash paid for income taxes (net of refunds) was $270 million for the year ended December 31, 2015. As of December 31, 2015, our federal net operating loss carryforward was $2.70 billion, although we anticipate only a relatively small portion of this will be available to offset our federal taxable income in 2016. As of December 31, 2015, we had $1.08 billion of federal tax credits, substantially all of which will be available to offset our federal tax liabilities in 2016. We expect that the amount of cash paid for income taxes to significantly increase in 2016.
Note that the $270 million is cash paid for “income taxes”. That would be anybody and everybody – states, foreign countries and the federal government. They are not required to break it down. From my poking at the financial statements, I think there is a good chance that Facebook has never actually paid any federal income tax, even though it has made for provision for it. Nobody seems to get excited about that.
Donald Please Keep The Returns Locked Up
Personally, I hope Trump does not release his returns before the election, but that is for purely selfish reasons. I would prefer not to have to comb through them and I would feel obligated to do it. I think there is enough in the public record to make a decision on Donald Trump’s record in dealing with other people’s money. When it comes to his organizing his life to minimize taxes, being of the Learned Hand school, I can’t hold that against him.
Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.