In Part 1, we looked hard at Buffett’s effective income tax rate (17.4%).
We tested the conventional wisdom that the rate is low because Buffett gets practically all of his income from capital gains and dividends.
Maybe and maybe not.
We showed that, in fact, almost half of Buffett’s income could be from ordinary income and he’d still pay the low rate.
Because deductions are first applied to higher taxed income (think ordinary income @ 35%) and then to lower taxed capital gains.
Buffett could, in effect, be getting his ordinary income tax-free.
Let’s dig a little deeper on Warren’s tax data.
The key numbers: AGI = $53 million, Deductions (aka. “loopholes”= $23, Taxable Income =$40 million, and taxes = $7 million … 17.4%
Let’s think about the deductions for a moment
Some pundits have theorized that many of the deductions are “interest on investment borrowing”, suggesting that Buffett buys a lot of his holdings on margin.
I don’t think so.
First, he’s a frugal guy who doesn’t strike me as margin kind of guy.
Second, interest rates are essentially zero … especially for a big hitter like Buffett … and zero times any balance is, well, zero.
Third, Buffett himself says it ain’t so.
He says the roughly $23 million difference between his AGI and taxable income is due largely to deductions he took for charitable giving and local taxes.
Let’s do taxes first.
Nebraska state income taxes have a max marginal rate of just under 7%. So, Buffett probably pays about $3 million in state & local taxes.
That leaves about $20 million in charitable deductions. It’s oft reported that many of those donations go to the Gates Foundation.
We’ll come back to the charitable deductions in a subsequent post.
We’re not saying they’re necessarily good or bad … just remember the $20 million number.
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Next up: How does the 17.4% compare to ordinary folks? And, is it the right number to focus on?