Did Warren Buffett Leave $675,000 of Tax Savings on the Table ?

Originally Published on forbes.com on August 24th,2011

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In my blog I seek to look at tax issues for items of practical utility, matter for reflection and humor.  Now I didn’t think that I would be able to find anything of practical utility in the Warren Buffett war that has been going on in the blogosphere but Robert Green’s piece How Warren Buffett Saves Billions on his Tax Returns has been haunting me.  Mr. Buffett’s piece had provided two key numbers and Mr. Green’s piece a third.  I’m going to round to the nearest million and say that Mr. Buffett had taxable income of $40,000,000 on which he paid 7,000,000 of tax.  According to Mr. Green this was based on 62,000,000 of adjusted gross income.  Another figure Mr. Green provides is that Mr. Buffett has a billion dollar charity carryover for gifts of appreciated property.  This lines up the numbers pretty well.  Someone with effectively an infinite amount of charitable gifts of appreciated property will have taxable income of 70% of his adjusted gross income before considering any other deductions which would bring us to $43,400,000.  The income tax rate in Iowa is 8.98%, which will bring us down to a rounded  $40,000,000.   I thought I had it nailed perfectly there.  Then I remembered it was the Wizard of Omaha, not the Wizard of Iowa.  (It’s not that I thought Omaha was in Iowa).  Nebraska is more like 7%, but that still accounts for most of it pretty well.  (I don’t want to get into the AMT here, but that is probably why Mr. Buffett is paying 17 % rather than 15%.  The state tax is deductible for regular income tax purposes but not for AMT).

My first managing partner was Herb Cohan.  I had the privilege of running some errands for his father the legendary Joseph Cohan, founder of Joseph B. Cohan and Associates, one of, if not the oldest, CPA firms in Worcester, Massachusetts.  I am the last person to become a partner in that firm, which was merged out of existence in the mid-nineties.  I just asked a young woman in our office what her Mass CPA license number is.  It is about 25,000.  Mine is 7,811.  Joseph Cohan’s was just over 200.  That’s heritage.

At any rate, Herb was an inspiration to me.  One thing you could count on.  If he ever had legitimate access to a return prepared by a lesser firm (There were no others of course) he would find a likely lad like myself and instruct him to figure out how we could have done better.  Now I only have a skeleton of Mr. Buffett’s return, but I can’t help myself.  I have to try.  The funny thing about a return like his, though, is that the very large numbers make a lot of things that would be of significance on other returns mere noise.

I do think that I have come up with something.  For the illustration I am going to make up someone named Ward Buffy.  Mr. Buffy had 62,000,000 in long term capital gains and made gifts of appreciated property of one billion.  That’s his whole return. (He lives in Florida and rents.  Let’s not quibble about the sales tax deduction). Yes, Mr. Buffy is the Wizard of Florida and I will be asking him to support Grace Medical next time I see him. His tax would be $6,504,900 on taxable income of  $43,396,350.  Assuming his basis was negligible that was a neat job avoiding capital gains tax on the billion dollars in gain even if much of the charitable contribution will expire in five years.  Could he have done better though ?  He could have.

Now the neat thing about making a gift of appreciated property is that you get a deduction based on the fair market value without having to recognize a gain.  So selling appreciated property and giving the cash would be a stupid thing to do.  Except in a situation like that of Mr. Buffy.  What would it look like if Mr. Buffy had given $985,000,000 worth of appreciated stock,   sold 15,000,000 and given the cash.  I used to have a colleague that would have yelled “That’s the stupidest idea, I ever heard.”  (Only I left out a word) . If he had done it that way Mr. Buffy would have had tax of $5,829,900.  How did doing the counterintuitive thing save Mr. Buffy $675,000 ?

Mr. Buffy has, effectively, an infinite supply of 30% charity for the next five years.  Regardless of anything else his taxable income will be 70% of his adjusted gross income.  That makes his marginal rate on capital gains 10.5% (70% of 15%).  Cash charitable contributions on the other hand are fully deductible up to the 50% limit.  If his only income is capital gains that will give him a marginal savings of 15%, until he bumps into the 50% limit.  15% – 10.5% = 4.5%.  4.5% of $15,000,000 is $675,000. QED.

This piece is really about tax planning not Warren Buffett.  When you have very charitable clients, you sometimes get odd results like this.  Run the numbers.  Don’t do them in your head. Test your assumptions. It’s not just charitable clients it’s anybody whose return has more than a couple of moving parts.  Another planning principle is not letting the tail wag the dog.  There may be compelling non-tax reasons for Mr. Buffett to be making, apparently only gifts of appreciated property rather than a combination of appreciated property and cash.  Those reason might be beyond my understanding.  I had that skeletal return though.  I just had to try.  It’s how I was trained.

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Note on my apparent geographic idiocy.  It is Omaha not Iowa.  So it is not geographic idiocy. I never thought Omaha was in Iowa. It is getting the sobriquet wrong.  The analysis still holds up though.  Since when I pushed the publish button this thing went out to a million different places, I’m putting this note here rather than redoing everything so that Forbes readers will be able to mock me along with the ones on Yahoo.  My guarantee to call out people who mock me does not hold if I mock myself first, but go ahead anyway.