Tax Break

Romney’s 2010 IRS return flags complex tax strategies

February 23, 2012

U.S. Republican presidential candidate Mitt Romney. REUTERS/Laura Segall

Republican presidential candidate Mitt Romney’s release of his 2010 tax return offers a rare glimpse at two sophisticated tax transactions which the U.S. Internal Revenue Service requires that taxpayers disclose for investments driven by tax considerations.

Like thousands of other Americans’ returns, Romney’s included special attachments flagging “reportable transactions” to the IRS. Known as Form 8886s, the attachments showed that these foreign currency and contingent swap transactions were undertaken by one Bain Capital fund and three Goldman Sachs funds in which blind trusts for the assets of Romney and his wife Ann have invested several million dollars.

Under disclosure rules strengthened in 2002 to grapple with rising tax evasion by Americans, the IRS requires taxpayers to disclose transactions that it has banned or warned it may challenge as improper.

The IRS has historically had a tough time detecting tax shelters, both innocuous and questionable, buried in taxpayer returns.

While the disclosure rules sometimes help the agency spot abusive tax shelters, they also can cause taxpayers to flag transactions that might appear on the surface to be problematic, but in fact are not.

Romney’s disclosures come in a campaign environment dominated by talk about income inequality and tax loopholes. (Yesterday Romney put forward his ideas for fixing the tax code.)

While the disclosures may raise more questions than they answer, they highlight the sophisticated tax planning – in this case, by some of the funds Romney is invested in – available to wealthy investors.

The IRS does not comment on individual taxpayers.

Spokespersons for Bain Capital, a private equity firm co-founded by Romney, and Goldman Sachs, one of the world’s largest investment banks, said there was nothing untoward or illegal about the funds or the Romneys’ investments in them.

Brad Malt, a lawyer at the firm of Ropes & Gray in Boston, is the trustee of the Romneys’ blind trusts, and is responsible for overseeing investment decisions for the trusts. Under blind trust laws, Malt picks investment funds, but it is the managers of those funds who decide what strategies they might use to earn profits and reduce taxes.

Malt referred questions to the Romney campaign.

The Romney campaign said it was being extra-cautious in flagging the transactions to the IRS. “These filings are purely informational, and merely pass along information provided by third party funds,” said Andrea Saul, a Romney campaign spokeswoman.

90,000 in 2009
Taxpayers filed 90,000 Form 8886s in 2009, according to an analysis of IRS data by the Government Accountability Office, an arm of the U.S. Congress. The IRS declined to provide data on how many of those disclosures involved transactions that were abusive  or improper.

“Disclosures like these have to be made when a taxpayer invests in a type of transaction or fund that has used a transaction that the IRS considers or may potentially consider to be a tax shelter,” said Bryan Skarlatos, a tax lawyer at Kostelanetz and Fink in New York.

He added that investment firms routinely err on the side of caution and disclose harmless transactions. The funds notify their investors about the transactions, who must then flag them on their IRS returns.

Romney released his 203-page tax return on Jan. 24 under political pressure to make it public. Before entering politics, he was an executive at Boston-based Bain Capital. His personal wealth is estimated to be as much as $250 million.

In principle, the economic benefits of the tax-motivated transactions flowed to the investors in the funds, who include Romney and his wife. The benefits are in the form of returns higher than those that would have been obtained without the transactions. It couldn’t be determined how, if at all, the Romneys benefited in this case.

The transactions, flagged in 16 pages of Form 8886s inside Romney’s personal tax return, fall into two categories.

One was a “foreign currency transaction” used by a Bain Capital hedge fund, Brookside Capital Partners Fund II LP. A blind trust for Romney’s wife, Ann, holds more than $1 million in that fund, according to financial disclosure forms filed in August 2011 by Romney as a presidential candidate to the U.S. Federal Election Commission.

A separate Romney family trust also owns a stake in Bain’s Brookside fund, but the size of that stake is unknown because Romney is not required to disclose it under Federal Election Commission rules that say so-called “qualified” blind trusts for which Romney or his wife are not beneficiaries do not have to be disclosed.

Romney’s tax return does not indicate how the “foreign currency transaction” worked or its formal name; only that it involved “ordinary losses” that were used to offset, or reduce, taxes in other unspecified areas. Ordinary losses include losses stemming from dividends and interest income. Over a series of rulings in the last decade, the IRS has required taxpayers to report losses of at least $50,000 that come from foreign currency transactions.

Second kind of transaction
The other type of transaction flagged involves complex financial dealings that generate paper losses that are used to reduce taxes due on actual investment gains, and can convert ordinary income to capital gains, thus lowering the taxpayer’s taxes due. In 2002, the IRS banned contingent swap shelters, and in 2006, it narrowed the scope of what was banned.

According to Romney’s return, these so-called “notional principal contracts” were used by six separate hedge funds in which investments are held by three Goldman Sachs hedge funds: Goldman Sachs Hedge Fund Partners LLC, Goldman Sachs Hedge Fund Partners II LLC and Goldman Sachs Hedge Fund Partners III LLC. The separate funds, not Romney, engaged in the transactions.

Romney’s return does not detail the inner working of this transaction in the funds.

Ann Romney’s blind trust holds stakes of more than $1 million each in Goldman Sachs Hedge Fund Partners LLC and Goldman Sachs Hedge Fund Partners II LLC, according to Romney’s personal campaign financial disclosure last August.

The Romney family trust owns stakes in the three Goldman Sachs funds, but their size is unknown because under federal election campaign rules, Romney is not required to disclose the assets of his family trust.

The six separate hedge funds in which the three Goldman Sachs funds are invested, as identified on Romney’s return, are run by Karsch Capital Management, Lansdowne, Maverick Capital, Sonterra Capital, Taconic Capital Advisers and Viking Global Investors.

Calls and emails to Karsch and Sonterra were not returned. An assistant at Taconic Capital said the firm’s only authorized spokesman, firm co-founder Ken Brody, was in the hospital. Spokespersons at Lansdowne, Maverick and Viking declined to comment.

A person briefed on the matter said that the Romney trusts had not sold their investments in the four funds because it was not practical, tax-wise, to do so, and because the funds were “highly illiquid,” meaning not easy to sell because they involve thinly-traded securities or partnerships.

Daniel Shaviro, a tax professor at New York University Law School and an expert in tax shelters, said Romney’s 8886 disclosures were “interesting” in light of Romney’s $4.8 million capital loss carryover from 2009, disclosed on his 2010 tax return.

The carryover means that in 2009, Romney’s capital losses exceeded his capital gains. The losses could legally be carried forward to 2010. Because Romney is heavily invested in private equity funds that generate capital gains, not capital losses, Shaviro said the origin of the capital losses was relevant to understanding Romney’s wealth.

Shaviro said broadly there were two options: either Romney lost money in the financial downturn of 2008, or he employed tax-saving strategies. “We would need more information from Romney to gauge what actually happened here,” Shaviro said.

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