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A Tale of Two Buffetts

February 23, 2012 by Lazy Man 36 Comments

Warren Buffett is the Oracle of Omaha. He exudes a very button-downed, no frills persona – still living in the same home that he bought for $31,500 more than 50 years ago. Over the years, he has amassed a fortune estimated at $35-$40 billion dollars. Buffett is an extremely skilled investor. His company, Berkshire Hathaway, has its hand in just about everything, owning some companies outright and holding substantial shares of others. Companies that Berkshire Hathaway has a significant piece of include GEICO, Pampered Chef, Helzberg Diamonds, Coca-Cola, Kraft, Wells Fargo, and Fruit of the Loom.

When Wile E. Coyote purchases building supplies, he goes to Acme Building Supplies. Who owns Acme? Berkshire Hathaway, of course. Stay out of my cartoons, Warren Buffet!

Nearly all of Warren Buffett’s income comes from capital gains. When he pays taxes on these gains, the tax rate is 15%. However, Buffett certainly had deductions (such as charitable contributions) that drive his effective tax rate even lower.

In contrast to the low key, buttoned down image of the Oracle of Omaha, Jimmy Buffett is the poster child for the party lifestyle. Buffett’s home base is in Key West, and his music fits the locale. The recurrent themes of escaping from the pressures of life and just relaxing strike a chord with millions of devoted fans who refer to themselves as Parrotheads. Many of his songs are just as relevant today as they were more than thirty years ago, and Buffett is a coveted collaborator, sharing the stages with the likes of The Eagles, the Zac Brown band, and Alan Jackson.

Jimmy Buffett has brought pleasure to millions of fans over the years. In addition to his songs, he has dabbled in writing – joining former Key West resident Ernest Hemingway and a handful of other authors who have hit #1 in both the fiction and non-fiction best-seller list.

Jimmy has also entered into a variety of licensing rights over the years. Across the country, you can find a number of Buffett-themed restaurants and casinos.

When Jimmy Buffet pays taxes on his touring revenue, album royalties, and licensing deals, it’s getting taxes at a rate of 35% – taking a bit of the spark out of Jimmy’s party.

On a number of occasions, Warren Buffett noted that his effective tax rate was less than his secretary’s. This has even attracted the attention of President Barack Obama who has proposed a tax plan called the Buffett Rule designed specifically to fix this tax inequality.

Ever wonder why Steve Jobs worked for a salary of $1 a year? Here’s a hint… it wasn’t because he was nice. It’s because he got his compensation in the form of stock and stock options. He knew that he could manage this type of income to pay less in taxes.

The Middle Class and Effective vs. Marginal Tax

Many middle-class Americans may be looking at the 14% number and thinking to themselves, “But I pay 25% in income taxes and I’m not making millions. Something is wrong.” Those people are right, a couple of things are wrong. First, many are not paying the 25% that they think they are. Many look at the tax brackets like this one for 2012 tax year (as a single filer):

  • 10% on taxable income of $0 to $8,700
  • 15% on taxable income of $8,700 to $35,350
  • 25% on taxable income of $35,350 to $85,650
  • 28% on taxable income of $85,650 to $178,650
  • 33% on taxable income of $178,650 to $388,350
  • 35% on taxable income over $388,350

… and make the mistake of thinking, “I make $50,000 a year, so I pay 25% in income tax.” Some will even try to find some last minute tax deductions to try to get under that $35,350 mark in an attempt to save big on taxes. Fortunately, that’s not how it works. Kosmo at The Soap Boxers explains how marginal and effective rates work. The person earning $50,000 of taxable income actually pays at each level. This breaks down to $870 at the 10% bracket, $3997.50 at the 15% and $3662.50 at the 25% bracket for a grand total of $8,530 in actually tax owed. This is an effective tax rate of around 17%, not the 25% that some expect.

Additionally, it is worth looking at the $50,000 taxable income number. Many people who make a $50,000 salary are able to reduce their taxable income number through deductions and programs like 401k plans.

The Tax Code is the Problem

Why are capital gains taxed at such a low rate? The basic idea is that there is more risk in equity investing than in investment vehicles such as passbook savings accounts. Some startups go the path of Apple, Google, and Facebook, but some startups are Lazy Man’s Beantown Hummus. (Let’s not talk about that business venture. ;-).) Thus, in order to ensure that people are stimulated to invest in startups, capital gains are taxed at a lower rate.

OK, I’ll buy into that. Tax capital gains at a somewhat lower rate than ordinary income. But ratchet the capital gains rate up a bit. The rates for ordinary income are progressive; why not have brackets for capital gains instead. Maybe a $50,000 capital gain is taxed at 15% but a $50 million gain is taxed at 25% or 30%. If you make that change, you’ve increase tax revenue by $5-7.5 million while still allowing the capital gain to be taxed at a lower rate than ordinary income.

Even if the person making $50,000 in taxable income isn’t paying 25%, it still seems wrong that billionaires can pay 15% on dozens of millions of dollars and an average Joe (not necessarily Joe the Plumber) is paying 17% on his ordinary income.

That’s a raw deal and it isn’t going unnoticed.


How to Pay Less in Taxes

It’s going to take an act of Congress to change the inequity between ordinary income and capital gains. Bear this in mind when you head to the polls in November. However, there are steps you can take to reduce your taxes:

  • Earn less money–Less income means you pay less in taxes! (OK, this is actually a really terrible idea. Don’t cut off your nose to spite your face.)
  • Take all your deductions– Don’t leave any money on the table. Take all the deductions you are legally entitled to. If you normally take the standard deduction, check to make sure it doesn’t make sense to itemize. If your life situation has changed substantially (buying a house is a great example), this can make a huge difference between taking the standard deduction or the itemized deduction.
  • Donate your crap–Still have that leisure suit that was actually in style once upon a time? Vinyl albums from the days when you had a record player and books from the pre-Kindle days? Donate them and you’ll get a tax write-off (assuming that you itemize). Added bonus? The items will actually be used by someone, instead of gathering dust in your attic.
  • Tax advantaged accounts– If you pay for day care, you can take advantage of a flex spending account for this expense. Medical expenses have more possibilities. Flex spending accounts for eligible medical expenses are relatively common, and you may also have the option of a health savings account (HSA) or health reimbursement account (HRA). These accounts all allow you to pay for expenses with pre-tax money.
  • Time your expenses – If you have some deductible items that are due to be paid in January, write the check in December. The most common case is with mortgages – paying the January payment in December results in a larger interest expense in the current year. In general, this is a case of robbing Peter to pay Paul, as it will reduce that expense in the next year (since there is no January payment). However, if you’re right near the cutoff of standard deduction vs. itemized deductions, it might save you money to itemize in the current year and take the standard deduction the next. It also makes sense to pull as many deductions in the current year if you expect to be in a lower tax bracket next year (if you are retiring, for example).
  • Contribute to a 401(k) – There’s plenty of debate about the decision of whether a Roth or 401(k) is the better option, which much of the decision based on your projected future tax rate. However, one thing that’s for sure is that contributing to a 401(k) will reduce this year’s tax bill.

Continue to Never Settle for Less by Filing online at H&R Block or in an H&R Block Office.

Though this article was sponsored by H&R Block, H&R Block did not supply any of content for the article. The article’s ideas/opinions are Lazy Man and Money’s and not H&R Block’s.

Filed Under: Tax Tagged With: capital gains tax, effective tax rate, H&R Block Offices, Jimmy Buffett, marginal tax rate, tax 2011, Tax Refunds, warren buffett

Invest in What You Know? (Part 1)

July 27, 2010 by Lazy Man 16 Comments

Recently a company emailed me to tell me about their product. The product re-introduced me to the idea of investing in what you know. Peter Lynch, of Fidelity fame, may be the biggest proponent, and Warren Buffett, may be the best known. When those two minds agree on any piece of investing advice, it is wise to listen…

… or is it?

I was a software engineer working on websites in 1999. (I’m sure you can see where this is going.) What I knew then was building websites. Should I have invested in them? In hindsight, the answer to that question is easy… No. It was extremely hard to know where to invest back then. I remember thinking that software was going to be distributed online and Egghead Software (Symbol: EGGS) was looking like it would be the Amazon.com (when Amazon was mostly books). It was trading at around $18 a share when I bought 100 shares. Later on that day it went up to $32 a share, but by the time my meeting was over it was down to $13. I suppose you could say that wasn’t investing… it was speculating.

I learned this lesson again recently. I know mobile phones relatively well. I know that Palm has one of the best mobile phones… the Palm Pre. You use it for a few minutes and it just feels right. I show someone it and even if they have an iPhone, they say, “Wow, that’s pretty cool!” So, my experiences told me that it was it wise to invest in Palm. Turns out that their marketing was pretty bad, and their exclusive agreement with Sprint went on a month too long. By that time, Verizon decided to put its promotion power behind the Motorola Droid. While I thought I was investing in what I knew, it turns out that I wasn’t. I wasn’t investing in the product only, but also the marketing and the company’s business execution.

As you can tell, I’m a little skeptical about the strategy of investing in what you know. In the next day or two, in part 2, I’ll expand on this topic as well as give more details about the company and their product. In the meantime, let me know in the comments if you invest in what you know or if you are skeptical like me.

Filed Under: Investing Tagged With: peter lynch, warren buffett

How I Invested My Roth IRA This Year

September 2, 2022 by Lazy Man 3 Comments

About a month ago, I asked you to help me invest my money. I got a lot of great recommendations. As he did last year, Get Rich Slick had the most creative idea, involving options trading. Like last year, I’m sure it will do fantastic. I’m currently not entirely comfortable with options at this stage. I understand the basics of how they work, but I would essentially be putting my money in something that I don’t understand. Doesn’t Warren Buffett say that you should invest in what you know?

I looked at the other suggestions. A few people mentioned investing in gold. I simply hate gold as an investment. I don’t like how it’s not a basic necessity of life in today’s modern world. It makes as much sense to me as investing in tulips. I know it’s stood the test of time, but I think times were different before flat panel TVs and flashy cars. People would use their gold collection to show off their value in society. Today, people use other possessions. I don’t see a trend toward people selling their useful possessions for a hunk of gold. If anything it’s the other way around.

I do recognize that gold has become a way to hedge inflation and the falling dollar. However, there are other ways to do that with assets that are required in the modern world. The rising price of oil is one such example. If all the gold disappeared from the earth, we could likely make due with copper wiring. If oil disappeared, much of the modern society would have great difficulty recovering. Another example is the raising cost of food. Again, it’s a basic necessity that people are required to buy.

For the above two reasons, I heavily considered oil (Powershares DB Oil Fund – Ticker: DBO) and food ETFs (Powershares DB Agriculture – Ticker: DBA). However, in the end, I decided that they were too expensive for me at this stage. They’ve simply appreciated too much in a small timespan. DBO is up 80% in the last year while DBA is up 45%. So I went with expanding my international exposure. I purchased 75 shares of Vanguard FTSE All-World ex-US ETF (Ticker: VEU), which is essentially unchanged over the last year. I felt I was underweight global stocks in what has increasingly become a global economy.

I want to thank everyone for their help. I found there was tremendous value in reading about different investment strategies.

Filed Under: Investing Tagged With: cost of food, dbo, etfs, flashy cars, flat panel tvs, gold, international exposure, Investing, investing in gold, options trading, powershares, price of oil, tulips, Vanguard, VEU, warren buffett

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