Berkshire Could Be In for a Nasty Tax Hit

The company might have a significant new liability under the new tax laws

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Sep 29, 2022
  • Berkshire is a low-tax operation.
  • But new tax laws could change the company's position.
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Earlier this week, I discussed some possible reasons why shares of Berkshire Hathaway (

BRK.A, Financial) (BRK.B, Financial) are coming under pressure, even though the corporation is perfectly positioned to deal with the current economic environment.

However, another important factor to consider is the threat of upcoming changes in tax laws on the company's bottom line.

Rising tax rates

Berkshire, under the stewardship of

Warren Buffett (Trades, Portfolio), has always been a very tax-efficient operation. It minimizes tax as much as possible by avoiding any significant transactions that may crystallize a taxable gain and reinvesting its profits back into tax-advantaged assets.

Buffett has a responsibility to organize the company in a way that reduces tax as much as possible for shareholders. It is his fiduciary duty to achieve the best returns for Berkshire's investors overall. One of the best ways of reducing money flowing out of the business is to reduce potential tax liabilities.

However, his ability to do this sort of financial engineering may be about to change. Berkshire could end up having a reduced ability to dodge taxes under the U.S. government's new corporate tax law.

In August, U.S. President Joe Biden signed a new law from Congress enforcing a 15% corporate minimum tax targeted at companies that earn more than $1 billion a year.

According to research conducted by the University of North Carolina Tax Center, Berkshire would have had to pay $8.3 billion in additional tax if this law had been in place last year. That would mark a significant increase in the company's taxes. Overall, the study found that about 78 companies would end up paying more taxes under the new law, raising a total of $31.8 billion for the federal government.

Of course, these are just estimates and projections at this stage. The projections do not necessarily mean that Berkshire will end up paying so much in tax every year going forward. Nevertheless, it is worth taking these projections into account. The company is only worth as much as the value of its future cash flows, and if cash flows are set to decline significantly thanks to having to pay taxes, then the intrinsic terminal value of the asset will decline.

Berkshire reported net earnings of just under $90 billion in 2021, although $62 billion of this was accounting for gains on equity positions. That leaves net earnings from operations of $28 billion. After stripping out the $8.3 billion it could have potentially payed in taxes if this new law had applied last year, Berkshire's earnings last year would have been a full 29% less.

Estimating the tax hit

These are just back-of-the-envelope calculations. To clarify, I do not think they are accurate. The law stipulates a 15% minimum tax, so I think there will certainly be loopholes to get around the 29% additional hit that the University of North Carolina Tax Center estimated. They are really designed to show the potential impact on the company's bottom line from the new tax law and may have been calculated with a specific political agenda in mind, which is why we can't take the results at face value unless we want to dig into doing our own calculations.

But while they may not be accurate projections, they do illustrate the level of uncertainty currently facing the business. As I mentioned in my previous article, one of the most considerable uncertainties hanging over Berkshire's stock today is how long Buffett will remain with the business. He might not be around long enough to capitalize on the current economic cycle and the opportunities that may emerge.

When you have this uncertainty coupled with the additional uncertainty of additional tax charges and reduced net income, the outlook for the enterprise suddenly becomes quite cloudy.

That being said, it is quite easy to see how this combination of companies will be able to continue to grow as the conglomerate capitalizes on its competitive advantages. One of Berkshire's biggest strengths is the fact that it has been designed to be impregnable over the long term. That is why so many investors trust Buffett with their money.

Still, if there is one thing the market hates more than anything else, it is uncertainty. And the uncertainty surrounding the business, which even includes the bulky conglomerate structure that has fallen out of favor with investors, may explain why it is struggling to live up to its past track record.

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I am/we currently own positions in the stocks mentioned, and have NO plans to sell some or all of the positions in the stocks mentioned over the next 72 hours. Click for the complete disclosure
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