Sunday, August 26, 2012
New York Times editorial: Two-and-Twenty Tax Dodges:
Mr. Romney and his partners may have abused the tax system by paying far less in taxes than they should have.
Back in 2007, The New York Times published an editorial that explained what was wrong with the tax treatment of Bain-like pay. It cited the work of Victor Fleischer, a law professor at the University of Colorado, who had written a let-us-count-the-ways report on how private equity partners avoid taxes [Two and Twenty: Taxing Partnership Profits in Private Equity Funds, 83 N.Y.U. L. Rev. 1 (2008)].
In a nutshell, they collect a management fee on their funds of 2%, which is supposed to be taxed as ordinary income. And they collect performance fees, usually 20% of any profits, which – thanks to a loophole that should have been closed long ago – are taxed as capital gains, at a mere 15%, about the lowest rate in the tax code.
It is no secret that Mr. Romney has availed himself of the super-low capital gains rate on his Bain performance-fees – an obscene privilege, but not illegal. What the Gawker documents indicate is that the Bain/Romney tax avoidance went further than that.
In brief, it looks like four Bain funds in which the Romney family’s trusts are invested converted $1.05 billion in management fees — which should be taxed as ordinary income – into capital gains, which are taxed at the much lower rate. The tax savings: $220 million.
Mr. Fleischer was all over it, writing on his blog that “the Bain partners, in my opinion, misreported their income if they reported those converted fees as capital gains instead of ordinary income.” What would the IRS say? It is unclear, but Mr. Fleischer says the practice is illegal and has no doubt a court would agree if ever asked to rule on the question. What does Mr. Romney say? The campaign declined to comment.