Warren Buffett was in the New York Times bragging about his low effective tax rate and saying how he would like to be paying more. Fellow Forbes contributor Tim Worstall weighed in quibbling about Mr. Buffett not factoring in the corporate taxes on Berkshire Hathaway's earnings. I'm just a simple CPA, whose firm won't even let him sign audit reports anymore. (That's true of all tax partners here by the way. I don't take it personally). I don't want to quibble with a quibble but apparently economists have a hard time figuring out the incidence of the corporate income tax (i.e. who is really paying it), so I think we can let go of that piece of the analysis.
Still, Mr. Buffett is not sharing the real reason that he doesn't pay much in the way of income tax relative to his great fortune. The secret is hidden in plain sight. Mr. Worstall alludes to it when he mentions that Berkshire Hathaway does not in fact pay dividends. Mr. Buffett's secret which you can find blasted all over the Internet is one of his famous quotations:
"Our favorite holding period is forever."
You only pay income taxes at any rate on realized appreciation. An investment with a holding period of forever incurs a capital gains tax of 0 percent, while all along the holder can be getting wealthy from appreciation. That's the real reason Mr. Buffett does not pay a lot of income taxes.
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