CEO Warren Buffett has long said that his favorite investment holding period is forever.
He likes to buy shares in companies like
(AXP), with durable franchises that Berkshire Hathaway can hold on to for a long time. Berkshire has owned Coke and American Express for more than 30 years.
One of the advantages of this approach was that it minimized taxes since Berkshire Hathaway (BRK/A, BRK/B) only paid taxes when it sold shares at a profit. Berkshire had about $245 billion of unrealized gains in its stock portfolio at the end of last year with nearly all of that in Apple, Coke, American Express and
the bank of america
(BAC), according to Buffett’s annual shareholder letter.
Berkshire shows a deferred tax liability on its balance sheet related to these earnings, but under the old accounting rules, these taxes may not be paid or never paid many years from now.
Berkshire, however, may have to start paying taxes on annual unrealized gains on its $327 billion stock portfolio starting in 2023 under the new 15% minimum corporate tax included in the recently signed Inflation Reduction Act by President Joe Biden. The tax applies to companies with annual profits of more than $1 billion.
Given the size of Berkshire’s portfolio, annual gains can be large in a bull market. Berkshire, for example, had $58.6 billion of unrealized investment gains in 2021 in its stock portfolio thanks to the market rally last year. No taxes were paid on these paper profits.
That will likely change when the alternative minimum corporate tax goes into effect in 2023. Robert Willens, a New York tax expert, says that if Berkshire had $50 billion a year in unrealized profits, it would likely have a tax bill of 7.5 billions of dollars.
“For regular tax purposes, gains are only taken into account when they are ‘realized,’ that is, when the security is sold or ‘otherwise disposed of.’ When a company records a profit for accounting purposes, but not for tax purposes, a deferred tax liability is created. Now, with the minimum tax on the books, this deferred tax liability will become an actual or current tax liability,” Willens wrote in an email to Barron’s.
But the new rules are complicated and the math may not always be so simple. There may be years in which Berkshire would not owe taxes on unrealized gains due to the size of its regular tax bill.
In an analysis published in Tax Notes International in November 2021, Martin Sullivan, tax expert and chief economist at Tax Notes, estimated that Berkshire would owe one of the largest amounts of tax among megacap companies based on a minimum corporate tax of 15 % for a period from 2018 to 2020. Its annual tax would have increased by an average of $3.2 billion over the period.
Berkshire officials did not return calls or emails seeking comment.
For the past several years, Berkshire has reflected changes in the value of its stock portfolio in its financial results, including its calculation of net income, based on rules imposed by generally accepted accounting standards (GAAP).
This has resulted in huge swings in Berkshire’s reported earnings and has drawn the ire of CEO Buffett, who tells investors to focus on the company’s core operating results and reconcile paper investment gains and losses.
Reported income related to stock gains on paper has not resulted in a current tax bill, but that is apparently set to change in 2023.
Write to Andrew Bary at firstname.lastname@example.org