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Here’s a not-so-shocking statement: people hate paying taxes.
A Pew Research poll found approximately 56% of Americans have a negative response to filing and paying their taxes with more than a quarter using the term “hate” (but honestly, I thought the percentage would be larger).
That said, another Pew poll found a surprising reason why Americans hate paying their federal taxes. Broadly, Americans are ok with the amount they pay in taxes, with only 27% saying the amount bothers them a lot.
The reason most don’t like taxes is the feeling that corporations and the wealthy “don’t pay their fair share.” 64% say it bothers them a lot that corporations specifically don’t pay their fair share, and 61% say the same about the wealthy in general. And that was before the 2018 tax cut bill that lowered rates for those groups substantially!
A recent ProPublica report appeared to give ammunition to these critics. Using stolen IRS data, the report noted that from 2014 to 2018, the 25 richest Americans paid a “true tax rate” of 3.4%. All told, these individuals saw their net worth increase by $401 billion and paid a total of $13.6 billion during that period.
As a comparison, ProPublica reported that middle-class Americans saw their net worth expand by $65,000 but tax bills amounted to $62,000… a true tax rate of 95%!
ProPublica’s fake true tax rate
Even the quarter of Americans that responded to the Pew poll that they “hate” paying taxes would begrudgingly admit they’re not paying anywhere near 95% effective tax rates. If you notice above, the ProPublica report used increases in net worth during this period in its true tax rate calculation. This is the biggest criticism of ProPublica’s article: it uses a definition for income known as “Haig-Simons.”
Why is that important?
Haig-Simons is a tax rate on net worth. Which is to say, if your Apple stock or home increased $100,000 in value last year, you’re not taxed on that under the IRS’s definition of income.
Instead, you pay capital gains whenever you sell (or dispose of) the asset. The IRS has good reason to structure taxes this way. For one, you don’t realize the benefits of an asset until you dispose of it.
Another reason is that small businesses and many other assets are hard to value on an annual basis. Founders of businesses paying taxes on value increases might have to sell them to pay taxes and the IRS simply doesn’t have the manpower for 150 million households.
And so, the main tax “secret” the richest Americans use is anything but!
Warren Buffett’s tax secrets: How he pays a “true tax” of .1%
Perhaps the most surprising name in ProPublica’s article is Warren Buffett. The Berkshire Hathaway CEO has long advocated for higher income tax rates for the rich and has even committed to giving away nearly his entire fortune upon passing! Yet out of the four richest Americans, Buffett has the lowest true tax rate at 0.10%.
The figures look even better for Buffett and the other richest Americans when you use the real income tax rate—which is an apples-to-apples comparison to the rest of America—save for Michael Bloomberg.
|Tax Paid||Wealth Growth||Income Reported||True Tax Rate||Income Tax Rate|
|Warren Buffett||$23.7 million||$24.3 billion||$125 million||0.10%||19.0%|
|Jeff Bezos||$973 million||$99 billion||$4.22 billion||0.98%||23.1%|
|Michael Bloomberg||$292 million||$22.5 billion||$10 billion||1.30%||2.92%|
|Elon Musk||$455 million||$13.9 billion||$1.52 billion||3.27%||30.0%|
ProPublica is not alleging illegality, and this is certainly not another Panama Papers—these individuals are too rich for that. It’s understandable, though, why some strategies have drawn the ire of the public as they appear to be perks for only the rich.
One heavily faulted tactic generally only available to billionaires is to use appreciated stock as collateral for loans to fund current-day consumption without incurring a tax liability. Others call to end the step-up basis in death, which essentially protects unrealized gains from being taxed.
While there’s room for discussion, it appears Buffett hasn’t taken any of these actions. He’s going to donate all his wealth when he dies and lives rather modestly, residing in the same home he purchased in 1958.
Buffett’s way to avoid taxes is simpler: he doesn’t cash out Berkshire Hathaway stock to spend his fortune on space travel, yachts, divorces, presidential campaigns, or houses. Because of the lack of consumption, Buffett doesn’t have to earn (realize) income! In fact, his reported income is only 8% of the second-lowest earner on the list of richest Americans, Elon Musk.
It’s unlikely you’re ever going to be as rich as Warren Buffett. But the same tools he uses to avoid and delay taxation are still available to normal investors. Buffett has been able to take advantage of delaying the capital gains realization to let his gains compound. Simply put, Buffett can choose when he pays Uncle Sam… and you can too when you own stocks.
Here are three investments that investors can use to take advantage of the same tax “tricks” billionaires use!
How Buffett’s Berkshire Hathaway is a tax-friendly investment
Berkshire Hathaway (B shares) (NYSE:BRK.B)
Market Cap: 637,887,224,762
Buffett’s commitment to tax-savvy investing extends to the company he runs. First, Berkshire Hathaway doesn’t pay dividends, which are taxable events in the year of the distribution. Why would investors want a dividend when your money is in the hands of the greatest capital allocator ever? By investing back into the business, Berkshire Hathaway avoids creating a taxable event for its investors.
But that doesn’t mean the company isn’t returning cash to shareholders. In his most recent shareholder letter, Buffett noted that the company repurchased $24.7 billion in share repurchases, which increased investors’ ownership by 5.2% for no extra money. Simply put, this was the equivalent of a 5.2% dividend yield with no taxes due!
At Millennial Money, we believe investing in high-quality companies is the best way for growing long-term wealth. As an added bonus, as Buffett’s own taxes show, buying and holding great companies without frequent selling that incurs taxes is one of the most powerful tax benefits at your disposal!
Last year there were faint whispers that Buffett had “lost it” as high-growth tech names exploded while his core operating businesses and portfolio holdings like insurance, banks, energy, and railroads lagged.
All told, Berkshire B-shares lagged the S&P 500 (dividends reinvested) by 16 percentage points (18.4% versus 2.4%), the second such year of significant underperformance (20.5%; 31.5% versus 11.0%).
This year Buffett is firmly in charge, nearly doubling the S&P 500’s return. Berkshire Hathaway is well situated for many of the themes popular this year like increased economic activity boosting demand from Burlington Northern Santa Fe and increased oil prices benefiting major holding Chevron. Buffett’s banking portfolio has had a boost from increased interest rates.
Apple is a share buyback giant
Market Cap: 2,199,262,889,490
Buffett knows a thing or two about great companies. That’s why his biggest holding is in Apple. As of the end of Berkshire Hathaway’s last fiscal year, Apple comprised 43% of their passive investment portfolio and more than half of all unrealized gains.
Apple CEO Tim Cook might not be on the list of richest Americans (he first became a billionaire last August), but he knows a thing or two about taxes, particularly on the corporate side. Apple didn’t repatriate overseas cash for nearly a decade to avoid U.S. taxes. It was a risky gamble as the company amassed a fortune of nearly a quarter trillion in cash but paid off handsomely when the 2017 tax cut allowed the company to repatriate at a reduced rate.
Unlike Berkshire Hathaway, Apple pays a dividend but it’s a minor portion of the company’s cash return policy. All told, the company has returned $551 billion in cash to investors since fiscal year 2012. Of those totals, $110 billion has been in the form of dividends with the rest being through share repurchases.
Simply put, 80% of Apple’s cash return has been non-taxable share buybacks and that’s not likely to change considering the company recently increased the share buyback authorization by $90 billion. Share buybacks will continue to dwarf Apple’s dividend payouts, which currently yield only 0.7% due to strong stock appreciation.
As America’s largest stock with considerable influence on both the S&P 500 and the Dow Jones Industrial index, it’s notable that Apple has underperformed both indexes year to date and is down on the year. However, this is understandable considering Apple advanced by 80% last year.
Recently there have been temporary concerns about Apple’s device sales in relation to last year’s surprisingly strong reception for the 5G iPhone, Macbooks, and iPads amid the pandemic. In addition, the company is in the midst of a high profile lawsuit from Epic Games and facing increased regulatory scrutiny.
Yet, it’s important to understand that Apple’s history of success is what has drawn Washington’s ire. You don’t get to become a multi-trillion-dollar company without making a few enemies. In the long-run, regulation is likely to be a non-event and the market continues to discount the company’s pivot to high-margin subscription and services revenue growth.
Bitcoin has a surprising tax benefit
Market Cap: $772 billion
One investment you won’t see in Buffett’s portfolio is cryptocurrency. At one point the Oracle of Omaha quipped that bitcoin was “probably rat poison squared” and his Vice Chairman Charlie Munger called crypto “disgusting and contrary to the interests of civilization.”
Yeah, but tell us what you really think!
No disrespect to Buffett, but we feel slightly different and are cautiously optimistic about crypto’s long-term prospects here at Millennial Money. Ultimately, we believe the world is still in the beginning stages of cryptocurrency adoption.
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Admittedly, investing in bitcoin isn’t for the faint of heart. Crypto is inherently volatile, with tokens moving 10% or more because of the inane tweets of billionaires (looking at you, Musk). Ultimately, volatility should subside as the crypto ownership base deepens among retail investors and institutions and the use cases for the asset grows.
If you’re like many crypto investors, you might currently be down on your investments this year. We understand, as bitcoin was featured as our investment of the week last month. While this isn’t ideal from an investment standpoint, it does have a surprising tax benefit that isn’t available for investors in the stock market.
Crypto has always been difficult for Uncle Sam to define and regulate, but that’s not going to stop the government from taxation. After deliberation, the IRS decided to classify cryptocurrency as property akin to investment homes, rather than as financial assets like stocks.
Many rules remain the same, including lower long-term taxation rates, but there’s one key difference for property: it is not subject to wash sale rules. This rule is applied to stock market sales, essentially establishing a 30-day before and after window during which you cannot buy stocks sold at a loss if you want to report the loss on your taxes.
The benefit, as covered in more detail by CNBC, is that if you’re down on your crypto investment, you can sell it to lock in a loss and buy back the same day. You’ll still be able to take a loss for tax purposes and offset stock gains during the year. Of course, the new position would obviously be subject to gains when sold.
While this is a benefit, remember that it’s difficult to call market bottoms and crypto will continue to be volatile for the foreseeable future. Ultimately, we think cryptocurrency has a long runway for growth as the asset class should be positively impacted by inflation (an erosion of the dollar) due to the scarcity value of its limited coin supply.
For investors with a high risk tolerance who believe in long-term investing, bitcoin is a good way to diversify your portfolio and take advantage of the next-gen economy with a little tax code benefit that could help along the way!