Following up on my previous post, WSJ: Private Equity Firms Save Millions in Taxes by Treating Dividends as 'Monitoring Fees,' Says Polsky: Chicago Tribune, Rauner Used Strategy Now Under IRS Scrutiny to Slash Income Taxes:
IRS data show Bruce Rauner to be one of the 11,000 richest tax filers in the nation, but most of the millions he made in recent years was taxed at 15 percent — less than half the top federal rate for the wealthy, a review of tax documents released by the GOP governor hopeful shows.
One reason behind that sharp discount is that Rauner took advantage of a strategy that yielded big tax savings on his share of investment fees paid to his private equity firm, GTCR. That strategy is allowed under tax rules but has come under IRS scrutiny.
An analysis of the limited records Rauner has released, conducted by the Tribune in consultation with tax experts, gives the fullest picture yet of the steps he took to trim his tax bill. In ways both big and small, the Republican businessman's financial profile is one driven by tax-reducing strategies often out of reach for those of more modest means:
Rauner's campaign is built around his resounding success at the helm of GTCR, through which he earned millions of dollars a year. But a major portion of that money was reported to the IRS as capital gains taxed at a preferential 15 percent, including money from so-called management fee waivers used by many private equity firms to reduce tax bills for key partners. ...
In a Tribune interview focused on his taxes, Rauner said his returns "very carefully" adhered to the tax code and that he paid everything owed. At the same time, he said he could not recall some details surrounding losses he claimed and deductions he took. ...
Central to Rauner's campaign is his financial success, which he argues is proof of the kind of leadership savvy needed to turn around a financially ailing state. But that approach comes against the backdrop of a broad national argument over the meaning of an ever-widening gap between incomes of the wealthy that keep growing and those of the middle class that have been stagnant for years. That debate led to political headaches in 2012 for former Massachusetts Gov. Mitt Romney, then the Republican presidential nominee.
And there are significant parallels between Romney and Rauner, both of whom made fortunes at the helm of private equity firms. During his campaign, Romney released two years worth of voluminous tax returns that provided considerable fodder for critics who argued that he took ample advantage of tax code loopholes favoring the wealthy.
While Romney released more than 700 pages of returns and schedules, Rauner's financial disclosures have been much less extensive. The campaign of the Illinois Republican has released copies of the two-page 1040 tax forms filed jointly by Rauner and his wife, Diana, for 2010, 2011 and 2012without any accompanying documents. The candidate sought an extension on filing his 2013 tax returns and has yet to submit them, a spokesman said.
In 2012, the intense focus on Romney's wealth and taxes spilled over into the business practices of his old firm, Bain Capital, which was found to have engaged in the same sort of fee waivers that have helped Rauner lower his taxes. Since then, the practice has attracted the attention of the IRS. ...
At its core, the fee waiver strategy is an accounting maneuver that blurs the line between management fees charged by equity firms like GTCR to manage funds for investors and profits generated by the firms' investments in the funds they manage.
In short, equity firms technically waive collecting on millions of dollars of management fees they are owed, but that hardly means they forgo the value of those fees. Instead, that gets reflected as a stake in the very investments they manage.
When the investment fund turns a profit, often within months, the equity firm receives the cash value of the waived fees and distributes that among its partners.
All that maneuvering might sound esoteric, but it carries profound tax consequences. Tax rates changed in 2013, but before that it meant the difference between paying a 35 percent rate on fee income or a 15 percent rate on investment income. ...
"It's a technique that is entirely tax-driven," said Victor Fleischer, a professor who teaches tax law at the University of San Diego and has written extensively about fee waivers. "There's no business motivation behind it." ...
"It's a total tax game. There is no nontax reason for it," said Gregg Polsky, formerly a professor in residence at the IRS who now teaches at the University of North Carolina School of Law. "In reality, everyone knows that. It creates the appearance of risk to try and get a tax result." Polsky said equity firms are at the controls of the investment funds they manage. He said the only scenario that could prevent them from recouping waived fee revenue is if a fund lost money from start to finish without a single profitable quarter. "If hell freezes over, they might not get their 2 percent, but that's not going to happen," Polsky said.