I agree with Buffett that the capital gains rate should not be substantially lower than the ordinary rate. But the real reason Buffet pays relatively little tax is that he actively manages the amount of his income and capital gains. In many years, it appears that most of his income was his $100,000 Berkshire salary (which would result in approximately $25,000 of income tax).  So his tax bill would be nominal even though his net worth is approximately $150 billion.

Also, Berkshire doesn’t pay a dividend so he would have no dividend income. In certain years, Buffett sold some Berkshire shares and paid a 20% capital gains tax on the gain. But even in those years, he could have reduced his tax by making charitable contributions to his (or others’) foundations.

Buffett ability to arrange his affairs to minimize his taxes is based on the fundamental concept under the current tax system that income and gain are taxed only when “realized”. If Buffet’s Berkshire shares increased in value by $10 billion but none of his shares were sold, he would only have a $25,000 tax on his $100,000 salary. There have been legislative proposals for imposing a wealth tax on rich individuals.  If a wealth tax applied to Buffet, his income tax liability would have, of course, been substantially higher (Up to $30 billion assuming a 20% tax rate). 

Under the current tax law, the government has the tools to impute income to Buffett and/or impose a tax surcharge on Berkshire, because Berkshire accumulated its earnings and did not pay dividends or compensate him at a market rate (Accumulated earning tax and Section 482). However, the IRS has rarely attempted to use these tools in the case of a large public company.

For example, Berkshire is like an equity fund run by Buffet as a Fund Manager. In that case, he would be entitled to a management fee of 1-2 percent and an interest in the Fund profits.  Assuming a Berkshire market value of $1 trillion, a 1% fee would be $10 billion and result in a $3.7 billion annual tax at a 37% rate. Under various provisions of the current tax law the IRS could potentially impute a $10 billion fee (or dividend) to Buffet. [Note that Berkshire may be able to deduct, subject to limitations, any compensation imputed to Buffett albeit at the 21% corporate rate].

Buffett is unquestionably charitable. He has pledged to give away virtually all of his net worth (Berkshire shares) upon death to a charitable trust managed by his children. As a result, Buffett will not pay any estate tax. Further, the charitable trust likely won’t pay any tax on the sale of Berkshire shares.

Accordingly, Buffett’s remaining Berkshire shares will escape tax during his lifetime and when they are sold by the Trust (with the exception of the government’s attempt to impute income to Buffett as discussed above).

[The question for the reader; is the current system fair and does it make sense? I’m not advocating a wealth tax but maybe a stronger mechanism to ensure that a stipulated amount of income is allocated to the shareholder].