W
Will
I was reading through one of Warren Buffet's annual reports for Berkshire
Hathaway, and it contain the following as an explanation for why he prefers
to buy companies instead of just invest in them as marketable securities:
"...there's also a powerful financial reason behind the preference, and that
has to do with taxes. The tax code makes Berkshire's owning 80% or more of a
business far more profitable for us, proportionately, than our owning a
smaller share. When a company we own all of earns $1 million after tax, the
entire amount inures to our benefit. If the $1 million is upstreamed to
Berkshire, we owe no tax on the dividend. And, if the earnings are retained
and we were to sell the subsidiary-not likely at Berkshire!-for $1 million
more than we paid for it, we would owe no capital gains tax. That's because
our "tax cost" upon sale would include both what we paid for the business
and all earnings it subsequently retained."
There are two components to this paragraph that I want to flesh out and
better understand:
1) If a C corporation wholly owns another C corporation, the parent is not
taxed on dividends paid by the child. Is that right? Obviously the child
corporation paid taxes on net income and the dividend is on after-tax
income.
I assume that this tax advantage would not exist if the parent was an S
Corporation? In that case, the dividend of the child C corporation would
flow through the S Corporation to the shareholders of the S corporation, and
it would be taxed just as if those shareholders had received the dividend
directly from the C corporation? Is the tax benefit he is describing here
only applicable if the parent is a C corporation?
2) His second statement seems to be that the dividends received by the
parent will increase the parent corporation's cost basis in the child
corporation by the amount of the annual dividend. That statement I find
remarkable. Since the government is not taxing the dividend, why would the
government double the tax benefit by also giving the parent corporation some
additional cost basis in the child corporation, which the parent could use
to shield the same amounts as the dividend from any capital gains on a
future sale?
Are there other similar cases to 2) in the US tax codes, where some kind of
dividend or ordinary income will increase cost basis in an asset?
Hathaway, and it contain the following as an explanation for why he prefers
to buy companies instead of just invest in them as marketable securities:
"...there's also a powerful financial reason behind the preference, and that
has to do with taxes. The tax code makes Berkshire's owning 80% or more of a
business far more profitable for us, proportionately, than our owning a
smaller share. When a company we own all of earns $1 million after tax, the
entire amount inures to our benefit. If the $1 million is upstreamed to
Berkshire, we owe no tax on the dividend. And, if the earnings are retained
and we were to sell the subsidiary-not likely at Berkshire!-for $1 million
more than we paid for it, we would owe no capital gains tax. That's because
our "tax cost" upon sale would include both what we paid for the business
and all earnings it subsequently retained."
There are two components to this paragraph that I want to flesh out and
better understand:
1) If a C corporation wholly owns another C corporation, the parent is not
taxed on dividends paid by the child. Is that right? Obviously the child
corporation paid taxes on net income and the dividend is on after-tax
income.
I assume that this tax advantage would not exist if the parent was an S
Corporation? In that case, the dividend of the child C corporation would
flow through the S Corporation to the shareholders of the S corporation, and
it would be taxed just as if those shareholders had received the dividend
directly from the C corporation? Is the tax benefit he is describing here
only applicable if the parent is a C corporation?
2) His second statement seems to be that the dividends received by the
parent will increase the parent corporation's cost basis in the child
corporation by the amount of the annual dividend. That statement I find
remarkable. Since the government is not taxing the dividend, why would the
government double the tax benefit by also giving the parent corporation some
additional cost basis in the child corporation, which the parent could use
to shield the same amounts as the dividend from any capital gains on a
future sale?
Are there other similar cases to 2) in the US tax codes, where some kind of
dividend or ordinary income will increase cost basis in an asset?