Warren Buffett may talk a big game when he mentions the ultra wealthy paying higher personal income taxes, but when it comes to Berkshire Hathaway’s taxes, he’s all about avoiding them.
The Berkshire Hathaway balance sheet has $49.5 billion in deferred income taxes, meaning taxes that Berkshire Hathaway has not paid. As a matter of fact, in every year but one during the last 10 years, the deferred taxes of Berkshire Hathaway have gone up.
How can Berkshire Hathaway – a company that currently has the ninth highest revenues in the world – get away with not paying so much in taxes?
It’s actually quite simple to figure out.
Holding Stocks Forever Has Its Perks
Warren Buffett is quite famous for saying that his favorite holding period for every stock is “forever.” This is a quote that has circulated everywhere, and people use it to justify everything from his desire to drink Cherry Coke to his principles of investing.
When Warren Buffett mentions buy-and-hold investing, he’s not just talking about the power that you gain from investing over long periods of time. He’s also discussing an investment philosophy that is phenomenal when it comes to being tax savvy.
Buffett loves buying and holding because it grants him the ability to avoid paying taxes on large returns on investment.
Because here’s the deal… You only have to pay capital gains taxes once you sell. So if you never sell and lock in your earnings, you can save a fortune on paying taxes this way.
Of course, it’s wise to realize that Berkshire Hathaway is eventually going to have to pay taxes on those gains. It’s going to happen. Eventually. But for an indefinite period of time of Buffett and company’s choosing, while compounding money quicker all at the same time, the business will be able to delay paying their tax bill.
How Does Buffett’s Strategy Affect the Average Joe?
The Berkshire Hathaway tax strategy is different than a person’s personal taxes. So let’s pay close attention to the things that affect you – like capital gains.
If you are like the majority of investors, you will pay about 15% capital gains tax on your capital investments. Capital gains can significantly lower your investment returns over time.
Here’s an example…
Let’s imagine that we live in a simpler time with only two stocks to choose from. Each of these stocks returns an annual 10%, every year.
You put $10,000 into one of these stocks and hold it for the next 40 years. At the time, you will sell this investment for a total of $401,447. After paying capital gains tax of 15%, you will receive $351,230. That’s not so bad! The buy-and-hold philosophy definitely paid off.
What happens if you are an indecisive investor? What if you traded back and forth every year, selling one stock to purchase the other, and vice versa?
By cashing in your gains each year and purchasing the other stock, you would pay capital gains tax every year as well. All of the various taxation adds up quite a bit at the end of the 40 years, and your post tax dollars would only amount to $283,543. That’s obviously a lot of money, but it’s much less than $351,230, which you would have if you stuck to one investment. You would end up losing over $67,000 of potential profits.
That’s precisely how Buffett avoids paying his taxes. When you buy-and-hold stocks for a long period of time, just like Buffett, you can avoid paying billions of dollars in taxes. Anyone can do it. This isn’t exclusive to the billionaire investor.