Comments on: The burden of Romney’s tax returns http://blogs.reuters.com/david-cay-johnston/2012/01/20/the-burden-of-romneys-tax-returns/ Sat, 23 Mar 2013 13:49:31 +0000 hourly 1 http://wordpress.org/?v=4.2.5 By: Gordon2352 http://blogs.reuters.com/david-cay-johnston/2012/01/20/the-burden-of-romneys-tax-returns/#comment-1025 Mon, 30 Jan 2012 17:54:48 +0000 http://blogs.reuters.com/david-cay-johnston/?p=267#comment-1025 Mr. Johnston,

I thought you might be enlightened by this article in Bloomberg, which is written quite well, and explains carried interest from the perspective of one who understands tax law.

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If Carried Interest Irks You, You Don’t Get It: William Dantzler

By J. William Dantzler Jr. Jan 29, 2012 4:00 PM PT

The release of Mitt Romney’s tax returns last week gave the nation a crash course in the mysterious “carried interest” that was said to allow him to pay 15 percent on millions of dollars of capital gains.

Unfortunately, more heat than light was shed on what a carried interest really is.

A carried interest is an ownership interest in a partnership that entitles the partner to a percentage of the profits but doesn’t obligate the partner to provide any capital. It is the other partners who provide the necessary capital, and they are thereby “carrying” the partner who does not.

A carried interest can arise in many contexts. It is fairly common on Main Street. My dad was a veterinarian who, as he got up in years, brought a young veterinarian into his practice. Although my dad did not call it that, the young veterinarian had a carried interest — that is a percentage of the profit with no obligation to invest capital.

Income from being a veterinarian is ordinary income, and thus the young partner with the carried interest paid tax on his share of the partnership income at ordinary income rates. If the underlying activity of the partnership, however, is an activity that produces capital gains, then the partner with the carried interest will have a share of the underlying capital gains and will pay tax on that income at a 15 percent rate.

Different Income

That is the situation with a private-equity partnership whose business is to buy companies and (it hopes) sell those companies a few years later at a profit. So, the only difference between an investor with a carried interest in a private-equity partnership and my dad’s young veterinary partner is that the underlying activity in private equity produces capital-gain income, and Congress has chosen to tax capital-gain income at 15 percent.

For a couple of years after President Ronald Reagan’s tax reforms were adopted in 1986, capital gains were taxed at the same rate as ordinary income. That was very unusual. In most recent years, capital gains have been taxed at a lower rate than ordinary income, and the differential was increased by the Bush tax cuts.

You can argue whether capital gains should be taxed at 15 percent, but that is a big issue having only a little to do with carried interest.

In all the years that capital gains have enjoyed a favorable tax rate, there has been a simple definition of what is a capital gain. It is simply gain on the sale of investment property, such as stock. The distinction between capital gain and ordinary income has never been based on the amount of sweat that went into producing the income. The workaholic investor who spends 60 hours per week researching stocks still earns capital gains that are no different, in the tax law, from the gains of an investor who gives little thought to his portfolio.

Bill Gates has a capital gain when he sells Microsoft Corp. (MSFT) stock even though, by most accounts, Microsoft would not exist without his considerable effort. Similarly, the distinction between capital gains and ordinary income has never been based on the amount of money invested or, indeed, whether there was any investment at all. An entrepreneur who starts a business with no investment (or more likely an investment by someone else with money) still generates capital gains on the sale of her business, and it is sometimes said that this fact accounts for the vibrancy of the tech economy in the United States.

What then would be the basis for saying that a private- equity executive with a carried interest should have his percentage of the capital gain from the sale of an underlying investment recharacterized as ordinary income? Is it because he sweats and the other investors don’t?

Well, maybe, but what about the full-time investor who sweats over his stock portfolio or the entrepreneur who slaved over her startup business. It is hard to make a distinction based on effort.

Plus, most private-equity executives earn large cash salaries that are taxed as ordinary income. Do we have to value the executive’s effort and see if it exceeds her cash salary, and then attribute that excess to the carried interest?

Tax Law Perspective

From the perspective of tax law, it just doesn’t make sense to have a tax distinction based on the sweat of the private- equity executive. A distinction based on the fact that the private-equity executive with the carried interest provides no capital to the partnership seems hard, too.

Do we really want a tax law in which only people who already have money can earn a capital gain? And, if earning a capital gain requires an investment, then how much? Does it have to be a big investment? Can it be borrowed from the other partners? Isn’t a carried interest in effect just a loan from the moneyed partners?

These are difficult questions that affect the entire structure of capital-gains taxation — not just carried interest. It would be very hard to draw a fair line between the type of private-equity investment that is deserving of capital gain treatment and that which is not.

It is perhaps not an accident that the carried interest discussion is taking place in the political arena — over Mr. Romney’s tax returns — rather than the worlds of tax law or tax policy, and that the advocates of taxing carried interest at higher rates are not tax experts who understand the complexity of the issue and the difficulty of drawing fair lines.

(J. William Dantzler Jr. is a partner at law firm White & Case LLP and head of its global tax practice. The opinions expressed are his own.)

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Carried interest is a “tempest in a tea pot” compared to the larger picture of how to account for capital gains taxes to ensure fairness in the tax laws. An argument over carried interest is like arguing over a single tree, when there is a whole forest to take care of.

PseudoTurtle
CPA/MBA

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By: vincent31 http://blogs.reuters.com/david-cay-johnston/2012/01/20/the-burden-of-romneys-tax-returns/#comment-986 Tue, 24 Jan 2012 21:01:40 +0000 http://blogs.reuters.com/david-cay-johnston/?p=267#comment-986 Demanding that Romney release everything is fishing for something that will embarrass him. We know nothing about Obama’s past. No records at all. These campaigns are a waste of time. Just vote. Divide. Pander. Pretend that the rich can pay for every social benefit and that they will. Pretend America can do what no other country has done. We can pay for benefits only by slow growth and higher taxes. The money has to come out of the investor class to go into the spending class. or the jobless class as they are called in Spain.

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By: vincent31 http://blogs.reuters.com/david-cay-johnston/2012/01/20/the-burden-of-romneys-tax-returns/#comment-985 Tue, 24 Jan 2012 20:57:46 +0000 http://blogs.reuters.com/david-cay-johnston/?p=267#comment-985 Romney worked for 25 years before holding office. His rivals made their money in or after office. As far as we know his “hidden” taxes were probed by IRS. High profile rich man gets audited. The taxes are a distraction. There are no poor, common-man presidents. I want someone who knows how to get the job done not give speeches on what is fair.

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By: vincent31 http://blogs.reuters.com/david-cay-johnston/2012/01/20/the-burden-of-romneys-tax-returns/#comment-984 Tue, 24 Jan 2012 20:55:11 +0000 http://blogs.reuters.com/david-cay-johnston/?p=267#comment-984 The UK battled back and forth on rate for carried interest, up and down, settling on a lttle bit higher than US. Enough to satisfy demogogues and low enough to keep capital at work in UK.

Then again Romney could pay more in tax and give less to charity. We all want the Feds to spend our money better than we can.

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By: vincent31 http://blogs.reuters.com/david-cay-johnston/2012/01/20/the-burden-of-romneys-tax-returns/#comment-983 Tue, 24 Jan 2012 20:52:52 +0000 http://blogs.reuters.com/david-cay-johnston/?p=267#comment-983 Double taxation: Corporations pay tax 35% on gains. What is left over increases value of shares or is distributed as dividends, taxed at 15% (or less, if lower income)–lomg term gains or qualified dividends. The assets are at risk. If taxation increases, more likely to invest in sure things, as Kerry did, municipal bonds and pay no tax. The poor get more for their FICA dollar than do the rich. If you pay no FICA you get no SOcial Security or Medicare benefits. Obama also proposes preferences for capital investment, except his best deals go to his buddies.

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By: Dave9000 http://blogs.reuters.com/david-cay-johnston/2012/01/20/the-burden-of-romneys-tax-returns/#comment-981 Tue, 24 Jan 2012 13:08:27 +0000 http://blogs.reuters.com/david-cay-johnston/?p=267#comment-981 Romney has to be worth more than $200 million; otherwise, he’s earning over 10 percent return on capital year-over-year, which is rare in this interest rate environment.

“One can only deduct $3,000 of capital losses from ordinary income. Any losses over that are carried forward to offset capital gains in future years.”

Not so. The super wealthy have tax loopholes that allow them to deduct far more than most ordinary mortals.

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By: jpe12 http://blogs.reuters.com/david-cay-johnston/2012/01/20/the-burden-of-romneys-tax-returns/#comment-980 Tue, 24 Jan 2012 01:03:38 +0000 http://blogs.reuters.com/david-cay-johnston/?p=267#comment-980 ” Hedge fund and private equity firms have spent a lot of money on lobbying and campaign donations to avert any such change.”

They ended those deferrals in 2008 w/ the passage of 457A. Maybe they’re spending money working on a time machine.

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By: jpe12 http://blogs.reuters.com/david-cay-johnston/2012/01/20/the-burden-of-romneys-tax-returns/#comment-979 Mon, 23 Jan 2012 21:17:37 +0000 http://blogs.reuters.com/david-cay-johnston/?p=267#comment-979 “On a capital loss he gets to take the full value of the loss and apply that against the full value of his REGULAR income”

One can only deduct $3,000 of capital losses from ordinary income. Any losses over that are carried forward to offset capital gains in future years.

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By: NobleKin http://blogs.reuters.com/david-cay-johnston/2012/01/20/the-burden-of-romneys-tax-returns/#comment-978 Mon, 23 Jan 2012 20:36:17 +0000 http://blogs.reuters.com/david-cay-johnston/?p=267#comment-978 @Okieknoppie

On a different article I posted the following comment and it applies to you…

“Your statement is a typical parroting of an baseless Right Wing Radio statement about Mitt’s income.

Capital Gains is absolutely not a double taxation.

Assuming Mitt paid taxes at the normal rate and then invested his ‘after tax’ income into dividend earning stocks, he is being taxed on the DIVIDEND, not the value or ‘Basis’ he invested. The Basis does not change and he is never taxed on this amount.

Further, if he were to sell the stock, the Basis would be used to determine whether he would pay taxes on a gain (at the 15% rate) or report a loss (if the price of the stock rises above what he paid, he has a gain, if the stock price is lower than what he paid he has a loss – if he sells). To be fair there are instances where the tax rate for Capital Gains is higher than 15% (max 28%) and there are differences between short and long term gains/losses, but a good tax and investment strategy will avoid the higher rates.

Where it gets interesting is how a guy like Mitt can apply the losses. On a capital loss he gets to take the full value of the loss and apply that against the full value of his REGULAR income…which doesn’t lower his taxes based on the 15% rate, but on the higher Federal Income Tax rate…

The timing of how they can do this is key.

Guys like Mitt can manipulate their investment strategy to pay minimal Federal Income Taxes using the capital gains and loss rules. His Trust pays an advisor a lot of money to do this for mim and his money.”

Super rich guys like Mitt have access to investment opportunities and investment protections the average investor/American does not.

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By: NobleKin http://blogs.reuters.com/david-cay-johnston/2012/01/20/the-burden-of-romneys-tax-returns/#comment-977 Mon, 23 Jan 2012 18:15:17 +0000 http://blogs.reuters.com/david-cay-johnston/?p=267#comment-977 An added note of interest is Romney’s dad, a wealthy man when he became a politician, who reported paying at a 38% rate with most of his posted returns.

I guess in reducing their ‘legal’ tax obligation by -23%, millionaires have come a long way since Romney’s dad’s day.

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