He’s known as the Oracle of Omaha, but maybe billionaire Warren Buffett should be crowned as the Emperor of the IRS, too. It’s hard to find any fault with the strategy of a man who has famously boasted that he pays a lower tax rate than anyone else in his office.
On the one hand, you could argue that Buffett has the means to hire a squadron of CPAs to riddle the IRS playbook with bullet holes. But his methods are neither obscure nor wrapped in secrecy: You just have to take a closer look. Although a peek into Buffett’s tax strategy might intimidate some folks who put off any thoughts of taxes until April 14, the rest of us can learn from how he does things. After all, decoding his methods isn’t nearly as hard as confronting the thousands of pages of the IRS tax code.
“The basic principles behind his tactics apply to taxpayers across most of the income spectrum,” said Jessie Seaman, a managing licensed tax professional at Tax Defense Network, a tax resolution firm headquartered in Jacksonville, Fla. “You might be able to optimize tax benefits by examining just a few of the opportunities Mr. Buffett takes advantage of when he files his return.”
It’s possible that Buffett isn’t so much avoiding tax mistakes as taking advantage of everything the law will allow. If he’s getting great advice, then it doesn’t hurt to learn his taxation two-step. Here’s a look at five tax mistakes that Warren Buffett doesn’t make.
1. He Doesn’t Neglect to Write Off Charitable Donations
Buffett has made many headlines over the years by giving away large chunks of the fortune he’s amassed. As recently as July 2015, he gave away $2.8 billion in Berkshire Hathaway stock to five different charities, according to CNN. Buffett makes significant donations each year and, when possible, he likely takes the maximum allowable deduction for charitable contributions, Seaman said.
So while giving is a good thing, it’s even better when it results in a tax break. “Any charitable donation should be tracked, recorded and receipts filed away so the deduction may be claimed,” Seaman said. “The more you can afford to donate, the more you get to deduct — so long as deductions are itemized.”
2. He Doesn’t Rely on a Paycheck
Getting paid at the end of the week feels great; having those taxes taken out and forking dough over to Uncle Sam in April, not so much. It’s a different story, though, if you’re in a position to tap money from a different source.
Passive investment income is Buffett’s answer. This includes sources such as dividends, which are taxed at lower rates than earned income. “Passive income is not subject to FICA taxes — Social Security and Medicare — which tacks on an additional 7.65 percent,” Seaman said. However, high-income households might have to pay a 3.8 percent Medicare tax on some or all unearned income, according to Fidelity.
Compare that to a whopping 15.3 percent for the self-employed on the first $118,500 of net income, and then 2.9 percent more on income over and above that. Relying on investment income rather than traditional wages “enables him to live up to the popular claim that he pays less in taxes than those he employs,” said Seaman.
3. He Doesn’t Pass Up Interest Income
Another way to bypass the paycheck-tax conundrum is to lean on interest income. At age 85, Buffett was eligible to draw on retirement accounts years ago. Assuming he did, he has a huge source of tax-free money at his disposal.
Many taxpayers who overlook this revenue stream failed to contribute enough to retirement accounts in their working years. If you work past age 65 to make ends meet, you’re paying taxes you could’ve in theory avoided. In fact, many more retirement-age people are working than just a generation ago: up from 12.1 percent in 1990 to 16.1 percent in 2010, U.S. Census figures show.
4. He Doesn’t Hold Off on Buy-and-Hold
The buy-and-hold strategy of investing works just as the name implies: You buy a stock and hold onto it for a long time. Buffett is a big fan of this strategy and has been known to squirrel away stocks for decades. The longer he holds it, the more valuable a stock becomes — he’s actually making money, but there’s no tax to pay until he sells off the asset.
“And if an investor such as Buffett realizes long-term gains on their investments, those gains are taxed at 20 percent, as opposed to the top tax bracket of 39.6 percent,” said Rod Smyth, chief investment strategist at the RiverFront Investment Group in Richmond, Va.
5. He Doesn’t Stop Swapping
A nifty trick from the Berkshire Hathaway book involves Buffett’s penchant for trading one highly profitable investment for a new one — and in essence starting from scratch, tax-free. He did it in 2014, when he traded $4.7 billion in Procter & Gamble stock for Duracell, “the copper-top” battery company P&G owned and was looking to sell.
P&G stock had made Buffett lots of money — and he could’ve owed more than $1 billion in taxes if he had sold it. Instead, by giving the stock back to P&G and getting Duracell in return, Buffett owed Uncle Sam nothing.