TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, August 27, 2012

Romney Reaped Huge Tax Benefits From 'Active' Role at Bain Capital

Huffington Post:  Mitt Romney Reaped Huge Tax Benefits Based on 'Active' Role at Bain Capital:

When tax experts charged that he benefited from legally dubious tax avoidance strategies employed by Bain, his campaign noted that the investments are kept in a blind trust completely out of his control. ...

But according to his 2010 tax return, when the IRS comes calling in April, Romney has a different answer: The presumptive GOP nominee reaps lucrative tax breaks for "active" participation in the private equity firm he founded, as well as a host of other investments. ... For tax purposes, he claims an active status; for political purposes, he claims to have zero to do with the investments. ...

The distinction is valuable, for the IRS treats passive and active income and losses differently. If a passive investment loses money, the taxpayer can only write off that loss if passive gains have also been made and only at a 15% rate. But active losses can be written off at a 35% rate and deducted from the taxpayer's ordinary income. In other words, a taxpayer wants active losses, not passive losses. So by describing many of his investments as active, Romney saves himself millions of dollars in taxes.

With those active investments, he is also securing a tax break few Americans enjoy: When he wins, he's paying a 15% rate on the gain. When he loses, he's writing it off at 35%, meaning that tax policy is subsidizing Romney's risk in his Bain investments. In other words, Romney didn't build that, at least not without taxpayer backing. ... These kinds of deductions are only available to "active" participants in business partnerships. While Romney filed as an active participant for tax purposes, there is no evidence that he took part in Bain management decisions in 2010, and he has denied doing so. ...

"Governor Romney appears to be saying one thing to the American people and one thing to the IRS," Rep. Brad Miller (D-N.C.) said to The Huffington Post. "Right now we are just seeing inconsistent statements. The American people are entitled to know more than that. If there's a legalistic distinction, we are entitled to know what that is. ... Has he played too close to the line or over the line?"

It is also possible that these deductions are all legitimate expenses for Bain and the handful of Goldman Sachs subsidiaries in which Romney is a partner. But they all appear on a tax document where individuals usually list personal expenses, known as Schedule E. And listing personal expenses as business expenses is not allowed.

(Hat Tip: Francine Lipman.)

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The authors made a mistake; they missed that trading partnerships are excluded from the definition of passive loss per 1.469-1T. Or: because they're investment & hedge funds, the trade & business expenses are necessarily nonpassive to Mitt. Here's from the example in the regs:

A partnership is a trader of stocks, bonds, and other securities (within the meaning of section 1236(c)). The capital employed by the partnership in the trading activity consists of amounts contributed by the partners in exchange for their partnership interests, and funds borrowed by the partnership. The partnership derives gross income from the activity in the form of interest, dividends, and capital gains. Under these facts, the partnership is treated as conducting an activity of trading personal property for the account of its partners. Accordingly, under this paragraph (e)(6), the activity is not a passive activity.

Posted by: jpe | Aug 27, 2012 3:37:07 AM

Can a Blind Trust be considered a trading partnership? I don't think that makes sense.

Posted by: Astraea | Oct 8, 2012 5:13:13 PM