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GreenTrader Weblog
GreenTraderTax & GreenTraderFunds
February 2, 2012
Cost-Basis Reporting on IRS Form 8949 Is a Nightmare and FATCA Makes the IRS a FATCAT
By Robert A. Green, CPA
In an attempt to balance the budget and close the "tax gap," Congress, the Obama administration and the IRS are on a mission to intimidate Americans into reporting all of their income, onshore and offshore. What's new on 2011 tax returns? Beefed-up reporting for securities traders with a problematic new tax form 8949, which deals with the IRS's new cost-basis 1099-B reporting rules. And, reporting of foreign assets over certain thresholds with new tax form 8938.
Before Congress and the President upset their political bases when they try to balance the budget by cutting entitlement or defense spending or passing new tax hikes, they want to close the tax gap (busting tax cheats), close special-interest tax loopholes, broaden the tax base and maybe lower tax rates, too (as suggested by the Bowles Simpson Deficit Commission).
The world is now the IRS’s oyster, and by using new sophisticated technology and productivity – just like the rest of us – the IRS is on a mission to catch tax cheats and taxpayers who conveniently overlook income and asset reporting.
Big changes on 2011 tax returns.
There are two new bombshells for our trader clients to deal with on their 2011 tax returns – the all new forms 8949 (Sales and Other Dispositions of Capital Assets) and 8938 (Statement of Foreign Financial Assets).
Securities traders will be shocked by the new tax-filing compliance headaches, red flags and problems caused by the IRS’s new Cost-Basis Reporting rules, which are all a part of its new tax form 8949.
Futures traders can count their lucky stars — they are free from this mess. With mark-to-market (economic reporting) in Section 1256, futures traders receive a one-page Form 1099 with their realized and unrealized gains and losses for the year. Simply enter that one simple number for “aggregate profit and loss” to Form 6781 and you also benefit from lower tax rates with 60/40 tax treatment. It may not be as easy if you trade instruments like ETF options. Brokers may treat those as securities, but you will want to treat them as Section 1256 contracts instead per our content.
Active securities traders and their accountants face a nightmare in filling out Form 8949 and reconciling their own trade accounting records — like TradeLog — with beefed-up broker-provided Form 1099-Bs.
First, these 1099-Bs are coming very late this year, as brokerage firms are struggling with the new rules. We expect most brokers will revise their 1099-Bs several times. This makes it almost impossible to file a full tax return by the April 17 deadline. You should get a good handle on your securities trade accounting with TradeLog and send that information to your tax preparer as soon as possible. Plan to file an extension, and be sure it’s valid by paying at least 90% of your tax liability by April 17 with the extension filing. Handle the difficult Form 8949 reconciliations and explanations required on your tax return after the extension and before the final due date of Oct. 15. Brokers may send revised 1099-Bs after April 15, too.
What’s the fuss with Form 8949?
You can’t enter information directly to Schedule D anymore, as you must use Form 8949 for all line-by-line reporting, received from the brokerage firm. This form has three types of situations (Parts A, B and C) for each short-term and long-term holding period (12 months) — potentially six different Form 8949s to deal with.
Part A — the good part — is used for cost basis that matches your 1099-B. As the instructions say “transactions reported on Form 1099-B with basis reported to the IRS.” For the 2011 tax return, this includes corporate stock purchased and sold in 2011.
These rules are being phased in, so many cost-basis items are not covered on 1099-Bs until 2012 and 2013. That’s where column B is used, as the instructions say for “transactions reported on Form 1099-B but basis not reported to the IRS.” This could include stock purchased prior to 2011 and other non-covered securities in 2011 like options, mutual funds and bonds. Form 8949 instructions also state, “If there are wash sales for items, reported on Part I-A, then you enter that adjustment in column (g) and with W code in (b).”
Caution: Taxpayers often disagree with brokers on reporting wash sales, and this can be a challenge to report on Form 8949. Tax software often only allows wash sales reported in this new column if there is a taxable loss. That can be a problem when summary reporting refers to a separate TradeLog report showing a net gain. Expect wash sale adjustments in situations where one broker doesn’t recognize a wash sale, which TradeLog may correctly recognize between a second brokerage account and an IRA.
Finally, Part C is for transactions where no Form 1099-B has been issued. This could be the case for a sale of personal assets or a home. We also may use this part for our transfers to Schedule C to allow home-office deductions.
Prior to this tax season, you could just leave the heavy lifting to TradeLog, and simply enter the 1099-B amount to Schedule D to satisfy the IRS. It’s a whole different ball game this year — you must do the heavy lifting. TradeLog is working feverishly to issue an update that makes it easier for you, too. Good trade accounting software continues to be a must for active securities traders.
Is it easier for Section 475 MTM traders?
GreenTraderTax has always recommended Section 475 MTM for securities business traders so they could be exempt from wash sales – which represent many of these difficult adjustments to be reported. Some traders have always incorrectly assumed that with Section 475 MTM, they could use summary reporting on Form 4797, stating “details available on request.” They are very wrong — Form 4797 requires line-by-line reporting too.
Plus, leading tax publisher RIA and PPC recommend that Section 475 MTM traders report total proceeds on Form 8949, and then back it out with an adjustment in Part C. While Section 475 MTM traders may be free from the mess of reconciliations on Form 8949, they still should fill out the form to avoid trouble. Its likely IRS computers will work in overdrive to match every individual’s Form 1099-B with their individual tax return and a Form 8949. We expect a huge increase in computer tax notices and headache and cost for taxpayers to deal with those notices. Get it right the first time to avoid getting a tax notice.
For more information and examples of dealing with Form 8949, watch our Webinar recording from Feb. 2, 2012.
Form a trading entity for 2012 to skip these problems.
After facing this nightmare once for tax year 2011, you will want to form an entity for your trading business in 2012 to skip these tax problems and unlock plenty of other tax savings. Entities currently aren’t required to file a form 8949; hopefully that continues to be the case for 2012 and subsequent tax years. Like with an individual Schedule C, the IRS turns up the heat on individual taxpayers, thinking they are less sophisticated and more prone to errors, whether inadvertent or purposeful.
Our important transfer strategy for sole proprietor business traders of moving some Schedule D trading gains to Schedule C to unlock home-office deductions and 100% Section 179 depreciation is even more of a red flag in 2011. It must be in that dreaded “Other” column on Form 8949. That’s okay, since we explained this transfer in our footnotes in the past anyway — but this year the IRS computers may choke on that more and send a tax notice.
This is not a problem with an entity return. The IRS is also beefing up audits of Schedule Cs and asked many traders to document and justify their trading expenses, too. The IRS audits entities much less. Our entity formation service is excellent and the price is right, so check with us soon.
In the past, we suggested entities for business traders only, since the AGI-deductions (retirement plan and health-insurance premiums) are beneficial with trader tax status. This year, investors may want to consider an entity as well, just to avoid the dreaded Form 8949 accounting and reconciliation mess that individuals face.
The IRS insists on knowing about material foreign accounts and transactions.
Over the past decade, it’s become increasingly easy for traders and investors to tap into foreign markets including emerging markets, tax havens and offshore funds. Plus, Americans move around the world for business or personal opportunities and they wind up with foreign accounts and transactions. Plenty of non-resident aliens marry Americans, or move to America becoming greencard holders and U.S. residents, too. Now, the IRS considers this all their business, too!
The Foreign Account Taxpayer Compliance Act (FATCA) is not just about tax reporting by Americans. It’s also to pressure foreign banks into divulging their American client information so the IRS can bust both the taxpayer and these foreign banks. Congress has gone on a similar extra-territorial path with Dodd-Frank and new CFTC restrictions for retail American forex trading accounts. The EU is reciprocating and also complaining about FATCA; perhaps a new Congress in 2013 will backtrack, or even this Congress in 2012. Stay tuned.
Oddly, another way to avoid Form 8949 headaches is to use a foreign broker, as they are not subject to these new complex cost-basis reporting rules for U.S. brokers only. But, then you trade in one set of tax compliance headaches for another, the foreign reporting ones which can be more onerous.
More details on FATCA, FBAR and the new Form 8938.
We wrote several blogs last year about Report of Foreign Bank and Financial Accounts (FBAR) on Form TD F 90-22.1. We also wrote about the IRS OVDI and OVDP programs, which the IRS recently reopened again (see details below). I blogged about Gov. Romney’s tax return — almost half of his 500+ tax forms had to do with foreign reporting. It must have cost him a fortune in tax preparation fees.
Another blogger did a nice job on this topic — see his blog here. He covers Form 8938 in full.
IRS announces third offshore voluntary disclosure program.
The IRS recently reopened an offshore voluntary disclosure program (OVDP) to allow taxpayers with offshore financial accounts (including brokerage accounts, mutual funds, pension plans and life insurance) or assets to comply with their U.S. federal income tax obligations and foreign account reporting requirements. Because the FATCA will force foreign banks to divulge information regarding their U.S. clients, U.S. taxpayers have a strong incentive to enter the OVDP rather than risk detection by the IRS. Once the IRS has begun an audit of a taxpayer, the taxpayer is no longer eligible to participate in the OVDP.
The new OVDP will be open for an indefinite period, but the IRS could choose to end it at any time.
The new program has no deadline to apply. However, the IRS emphasized that the terms of the new program could change in the future. The IRS stated that, for example, at any time the penalties under the program could be increased.
Bottom line
If you are going to be snagged with Form 8949 adjustments, and or reporting of foreign tax matters, make sure to get a handle on your tax preparation plan sooner rather than later. Don’t spring this on your tax preparer at the last minute and it’s a huge mistake to hide anything foreign.
Blog Notes About Politics From Robert Green
By Robert A. Green
I apologize to anyone who is offended by the Republican slant in my blogs. I’d like to explain where this comes from. My neighbor and close friend in Connecticut — a passionate Democrat — once explained to his Democratic friends that I am a Republican for my business to advocate for lower taxes, but that personally, I’m an independent. I am open-minded and my thinking transcends partisan party lines. But my neighbor is right, I do advocate for lower taxes, which is my job as a CPA focused on tax savings for my clients.
As the leader of TradersAdvocacy.org and CEO of GreenTraderTax, I defend the lower-tax interests of traders, investors and investment managers. That means fighting off tax hikes like a potential financial-transaction tax (FTT), which could put active investors out of business, and working hard to retain lower tax rates on long-term capital gains taxes and qualifying dividends, carried interest for investment managers and lower 60/40 tax rates on futures.
In my recent blogs, I supported Gov. Romney’s tax returns, as they are typical for a successful global investment manager or private equity executive, but I also raised some lingering questions. In "Republicans And Democrats Dicker While The Deficit Yawns And Rome Burns,” I chastise Republican orthodoxy and the Grover Norquist tax-protection pledge applying to the expiration of the temporary Bush-era tax cuts and I also take Democrats to task over many spending issues. As my Forbes editor says, “There is no political officer on board here!”
Tax reform is on the table in Washington and many state capitals. The entire tax code is being dissected and analyzed, with many tax breaks being relabeled as tax loopholes and targeted for closure. The goal of tax reform is to lower tax rates for corporations and individuals alike, and to offset that with closing tax loopholes and special-interest tax breaks, thereby broadening the tax base, which hopefully will lead to growth in the economy and tax revenues, too.
My job is to focus on taxes and not spending, as other writers address spending. Each special-interest group will defend their own tax turf, but there aren’t many that defend the interests of the small-business trader, active investor and small investment manager. Big banks and big hedge funds have their own associations and lobbyists, but small traders don’t. Learn more about our efforts at TradersAdvocacy.org.
One thing is certain: Populist outrage is targeted against Wall Street, big banks and hedge funds. Often, that fury leads to tax hikes aimed at Wall Street, yet Wall Street often deflects those attacks, and the tax hikes fall on Main Street traders — our clients. That’s exactly the case with the financial-transaction tax.
I do not want to defend the interests of the 1% only, as many of our trader clients have incomes far lower.
If you are a Democrat, please read my blog with a grain of salt, and focus on the technicality of tax and regulatory policy that I am addressing. If you see a zinger once in a while, it’s part of my writing style to provoke thought and viewership on Forbes, and other media where my blogs appear.
I do not want to offend anyone; I just want to defend the interests of traders. Please share your thoughts and comments with me, as I value them very much.
January 26, 2012
The Buffett Rule is Bad Tax Policy, Keep Lower Long Term Capital Gains Rates
By Robert A. Green, CPA. Blog Notes About Politics From Robert Green.
Green's Forbes blog version: Buffett Rule Is Bad Tax Policy.
Mitt Romney’s tax returns have reignited discussion over the lower long-term capital gains tax rates.
The Buffett Rule
In his State of the Union speech, President Obama called for a new 30% minimum tax on taxpayers with income over a million dollars. Many wealthy Americans have significant investment portfolios, which sometimes generate a large amount of capital gains income taxed at the lower 15% tax rates. Many of these taxpayers have an effective tax rate close to 15% because they offset ordinary income with charitable tax deductions, avoiding alternative minimum taxes (AMT) of 28%, too.
The Buffett Rule Revised
Before President Obama opens the door to an attack on capital gains tax rates – which his minimum 30% “Buffett Rule” tax really does – he should first propose disallowance of charitable deductions against AMT on people making more than several million dollars per year. I’m not in favor of tax hikes, but the President should go this way first in his proposal. It’s not fair that AMT, which was originally passed to tax the super wealthy, now mostly snags people with upper-middle-class incomes. Reform AMT first.
Heck, why not even consider (in jest) a Democratic AMT, so rich Democrats can pay more to fund the bigger government they demand? Why did Mr. Buffett pledge half his net worth, most to Bill Gates’ charitable foundation, and justify it by saying he doesn’t trust government to spend his money wisely?
Double dip vs. double taxation
Let’s compare double-dip charity tax breaks vs. double taxation on dividends and capital gains.
Mr. Buffett receives a double-dip tax break when he donates his appreciated shares in Berkshire Hathaway to the Bill & Melinda Gates Foundation. His first million-dollar tax break each year is the charitable tax deduction at the appreciated value – limited to 30% of his income with the rest carried over — against both regular taxes and AMT taxes. His second even bigger tax break is exemption from capital gains taxes on the shares he transfers – effectively sells — to the charitable foundation. Learn more in my blog on Buffett’s tax benefits.
Now compare that double-dip tax break to the double-taxation paid on dividends, and in some cases, capital gains, too. When a taxpayer receives a dividend, taxes are often first paid on the corporate level, perhaps at 35%, and a second time on the individual level at either 15% for qualifying dividends or up to 35% for ordinary dividends. Do the math and the double tax rate can be as high as 57.75% and that’s just federal. It’s no wonder companies like Apple don’t want to pay dividends and they arrange profits offshore. We need tax reform — lower corporate rates, NOT tax hikes from President Obama.
Does Gov. Romney pay double taxation?
As Gov. Romney took heat in explaining his tax returns this past week (see my blog), he and conservative-leaning pundits defended lower capital gains tax rates, arguing that it’s effectively double taxation. While this argument is correct in general, it’s not always the case.
Take the case of Mitt Romney. Private-equity firms may acquire or invest in turnarounds and startups, and use debt to fund their targets, so the target companies may generate operating losses, rather than profits in the initial years. In some cases, private equity investors structure their deals to pass-through operating losses, benefiting at 35% rates. Later, they rebuild the companies and sell them for a profit, and pay 15% long-term capital gains rates. So, the standard defense may not be the case for private equity and Romney’s situation.
Why should interest be tax-preferred over dividends?
Consider how dividends relate to interest income. In the case of investing in companies, corporations can’t deduct dividends, whereas they do deduct interest expenses, which favors debt over equity. That’s proven to be bad tax policy since it contributed to excessive leverage and unsustainable debt levels, which are now crippling the economy today, as many deleverage.
For an investor, interest income and qualifying dividends shouldn’t be taxed as ordinary income tax rates up to 35%. It’s fair for interest income to be taxed up to 35%, since it’s deducted by corporations saving tax at 35% corporate rates, or even other individuals saving taxes at up to 35% individual rates. So, it’s a wash in the case of interest income and expense. By the way, this is another reason to keep corporate and individual tax rates the same. If you lower corporate rates to 25%, lower them for individuals to 25%, too.
Conversely, when corporations pay ordinary and qualifying dividends, they aren’t tax deductible, so the corporation still has to pay the 35% rate. When the investor pays taxes on dividends, it’s double taxation. In these cases, some could argue that dividends shouldn’t be taxed at all. Perhaps a 15% double taxation rate is reasonable, considering that it’s not double taxation in every instance and the rate isn’t too high. But, shouldn’t ordinary dividends also receive the lower tax rates? Otherwise, Congress should allow corporations to deduct dividends in the same manner they can deduct interest expenses to level the tax and financing playing field.
Keep lower capital gains and qualifying dividend tax rates at 15%. If Democrats propose hiking tax rates for the super rich, be very leery as they could expand that to others next.
Tax hikes on dividends and capital gains will depress growth
I hope Congress and the President will think twice about raising taxes on dividends and long-term capital gains and disallowing interest expenses. Tax hikes on financing could cripple growth, and that’s what is needed most at this juncture in our fragile recovery. Europe is attacking finance and passing anti-growth austerity measures, it could plunge them into severe recession and further crisis. The U.S. can’t afford those types of mistakes and Gov. Romney is absolutely correct about all this, too.
The Bush tax cuts expire this year, raising taxes on dividends and capital gains
Caution, the qualifying dividend tax rate of 15% will expire at the end of 2012, so qualifying dividends will be taxed at the ordinary rate, which is headed higher, too. According to the Tax Policy Center report “Tax Rates on Capital Gains,” “the expiration of the Bush-era tax cuts and imposition of taxes associated with the 2010 healthcare legislation will boost the maximum tax rate on gains to 25 percent in 2013.”
Year-end tax planning
Get your dividends and long-term capital gains at lower rates in 2012 before these tax rates head higher in 2013. Will tax-rate selling affect the markets in Q4?
Bottom line
If the President wants billionaires like Mr. Buffett to pay more taxes, he should ask his friend to give the government more money, rather than fork over half his net worth to charity. President Obama needs to close the tax loophole for the double-dip charity tax break. Dividends are already double taxed, so don’t triple tax them and depress growth.
January 24, 2012
Gov. Romney’s taxes look to be compliant. Sure there are some valid questions, but that’s the case with most taxpayers.
By Robert A. Green, CPA. Blog Notes About Politics From Robert Green.
Green's Forbes blog version: Mitt Romney Is Hardly A Pig When It Comes To Tax Deductions. It's a little different up top.
Gov. Romney’s tax returns are complex, but that is par for the course for someone who is compliant with overly detailed and onerous IRS rules, especially on all things foreign. Sophisticated high-net-worth taxpayers with access to Goldman Sachs and other big bank investment programs have this type of complication and compliance. This return probably is confusing to most Americans who don’t have these types of investments, but I’ve seen many returns like this before and frankly, this one has more reporting than most. Perhaps it’s because Gov. Romney is running for President and he has great CPAs and tax attorneys working for him.
It seems to me that Gov. Romney benefits from lower long-term capital gains tax rates and deferral with his IRA. Some qualifying dividends were taxed at that lower rate, too. Gov. Romney benefits from lower tax rates from carried-interest and futures as well. I don’t see big deductions, passive-activity losses were left on the table in 2010, and he seems unaggressive. He doesn’t seem to be deferring or hiding any income offshore, either. Gov. Romney is probably well diversified and prudent with his investments. Look at that large interest income and dividend amount — he is likely buying and holding good stocks too.
Gov. Romney could have been more aggressive on some tax reporting. He used Schedule C for author and speaking fees, yet took very few expenses in connection with those activities. If he really was “not paying a dollar of taxes more than he should,” then he would have deducted more business expenses. Conversely, Sen. Edwards used an S-Corp to reduce self-employment tax (the S-Corp loophole), whereas Gov. Romney did not. He paid full self-employment tax (Social Security and Medicare) on his material business income.
Romney has little municipal bond interest income, which means he paid more Massachusetts state taxes than others customarily do. Was Romney worried about munis? He has a good amount of U.S. Treasuries, and every patriot saves some state taxes on that strategy. Overall, his tax return looks like a wealthy retiree with a large investment portfolio, and he has the luxury of waiting to generate long-term capital gains. He did report a $4.8 million long-term capital loss carryover from 2009, which may have been related to the financial market meltdown in 2008 and 2009, which points out that there is a downside risk to investing too. In 2010, Romney had plenty of passive-loss carryovers, so he is not trying to milk every loss on his return by hunting for passive-activity income either.
Like Obama’s billionaire-tax-poster-boy Warren Buffett, Romney offset his ordinary income with charitable deductions, thereby delivering the lower long-term capital gains tax rate overall. Romney triggered the nasty AMT tax, which means he did not get the tax benefit of investment expenses and or higher state tax deductions. Notice Romney didn’t try to move to New Hampshire (tax-free on portfolio income) or Florida or another tax-free state, like so many wealthy people do these days to avoid state taxes. Plenty of rich people defer taxes by holding gold, too.
Romney didn’t do the massive double-dip charity tax dodge to the extent that Buffett did (see my blog How Buffett Saves Billions On His Tax Return). Romney has a donation of stock valued at $920,000 on his 2010 Form 8283, but I am not sure how much the fair market value exceeded his cost basis. In 2010, most of Romney’s charity is $3.1 million of cash paid to his church. Buffett avoids long-term capital gains taxes on shares of stock he donates to charity, and he also gets the full charitable tax deduction at the fair market price.
Romney rushed to close his Swiss bank account in 2010, and he may have planned to avoid that embarrassment by releasing 2011 tax returns only. Swiss bank accounts got a lot of negative publicity in 2010 and 2011 when the IRS busted UBS over helping Americans hide income in Swiss and other offshore accounts. None of that appears to be a real issue for Romney, as PWC has pages and pages of foreign reporting – almost half his huge return - and you can see how complex and difficult that foreign reporting is, as the IRS is all over that issue. FBAR reports will be included in 2011, I presume, and they were filed separately with the Treasury for 2010. Romney is probably fully compliant on foreign reporting, and I noticed his tax forms and statements related to PFIC, controlled foreign corps, transactions offshore and much more. With PFIC reporting, Romney doesn't defer offshore fund income, so being foreign is not a special tax break. PWC prepared the returns and they know Romney is running for President.
I am guessing Romney’s 2009 tax return may have significantly lower income, since he paid most 2010 taxes with his 2010 tax extension, rather than as estimated taxes during the year (he used the safe harbor exception). He filed 2010 on the last possible day Oct. 15, 2011, which is what most rich and sophisticated taxpayers do. Like others, Romney has to wait for reports from funds and trusts, who themselves file extensions. What accountant has the time to finish Romney’s monster return before April 15? Let’s see them try to do that this year.
The 2010 tax return has several Form 8886s, which are not necessarily tax shelters, but special disclosures required by the IRS. It’s not clear to me why; the forms appear mostly blank and reference investment partnerships in trusts. Form 8886 is a heads-up “red flag” filing for the IRS. I feel bad for the IRS agent who gets this return dumped in his or her lap.
I have some lingering questions in connection with Romney’s very large IRA. Unlike qualified plans, you don’t have to file an annual Form 5500 on an IRA, and without UBIT offshore, there are no tax filings for this IRA. A Form 1040 just reports IRA annual contributions, non-deductible cost basis (Form 8606), withdrawals, distributions, rollovers and conversions. Form 1040 does not report the history of transactions in an IRA, which may be of interest to the voting public in this case. If a person planning to run for public office wanted to keep some transactions hidden from disclosure, they might choose an IRA vehicle for such a purpose. A traditional IRA is good for deferral of income, as you have ordinary income taxes in retirement on distributions and required minimum distributions (RMD) must start by age 70 ½. You can donate those RMDs to charity to avoid taxes, too. Some have pondered paying capital gains taxes instead of ordinary taxes in retirement, but deferral until retirement and beyond may be better than capital gains taxes paid every few years.
Did Romney receive any business income — perhaps disguised as carried-interest of advisory fees in the form of a profit-allocation of portfolio income — in his IRA? Did his IRA at any time own a share of his offshore investment management or private equity business? If the answer is yes, in my view — but not all tax attorneys agree on this — that could open questions about “prohibited transactions” or “self-dealing” for IRAs and IRS penalties for those prohibited transactions are very high.
Romney’s financial disclosure forms and media reports indicate that Gov. Romney’s IRA is close to $150 million, and it represents the lion’s share of his net worth. The WSJ questioned Romney’s Unorthodox IRA, wondering how it got so large, mentioning it’s unusual for high-net-worth taxpayers. Consider that contributions — only allowed on earned income — are limited to around $5,000 per year. Contributions to a 401(k) plan could be around $15,000 per year historically. So, you can’t build up an IRA to that amount based on contributions only, or even with rollovers from other types of retirement plans. You need growth from investments. Sure, Romney had plenty of that too, and with leverage the returns were probably even higher. There are no worries about UBIT caused by leverage in an offshore fund organized as a corporation.
It almost seems like Romney made a 100-times or more return. Did his investors do the same in the Bain Capital funds that he invested his IRA in? If not, then Romney has a higher return. A good question is, how can that be? I wonder if the answer could be it’s from carried interest or special allocations to Romney’s IRA, perhaps related to his role as an investment manager or private equity executive that helped build those investment deals. Carried interest should be paid to an investment manager, a business entity, and, in my view, not to a retirement fund, even if the retirement fund owns the business, which also can be a problem. If any growth in an IRA is attributable to business income, this could be a problem.
Not all tax attorneys are in agreement on this point, and the law is unclear. This hits at the heart of the tax loophole for carried-interest. Some tax attorneys might argue that one reason to permit carried interest in Romney’s IRA is that technically, a carried interest is not compensation income but simply a partnership interest which may be bought and sold. In a sense, it’s the character of the underlying income that counts, and in this case, it’s portfolio income. Perhaps, in 99 percent of the cases a carried interest is a payment for investment management, but it doesn’t have to be. If you agree that carried interest is allowed in an IRA, then another important question is whether a carried interest contributed to Romney’s IRA was undervalued when it was contributed to the IRA, in order to comply with the $5,000 annual limit (which varied by year). How can a huge carried interest fit into a small contribution valuation? Taxpayers face penalties for contributions in excess of allowable amounts.
Will the IRS audit Romney to find out more? The IRS is escalating its audits on taxpayers with million dollar or more incomes and taxpayers with foreign reporting. Romney’s tax posture otherwise seems typical, customary and compliant for a rich and sophisticated investment manager or private equity executive. Romney seems to have earned lots of money from doing great business and investing, and apparently his investors did great too. It seems legal and tax compliant.
Romney’s 2010 tax returns must have cost a fortune to prepare, more than what many Americans even pay in taxes. The number of tax forms and rules regarding foreign items is huge. It’s a cautionary tale from the IRS to stay local in the U.S. Many tax preparers overlook these foreign-reporting forms, but PWC did not in this case. The trust returns are complex and they house more of the same items mentioned above. But, the trusts seem to pass through income, gain, expense and loss to Romney’s Form 1040. Romney’s return also shows why we need a simple and easier tax code to follow with less complicated rules and tax form instructions. Foreign transactions should not be vilified, either.
Romney’s tax advisers don’t want to defend carried-interest tax breaks for investment managers and private equity managers at this juncture, so in their conference call today, the WSJ says they hinted at Romney offering up repeal of carried-interest tax breaks — something President Obama is dead-set on doing — providing it’s part of a meaningful and fair tax reform deal. It’s unfortunate if investment managers get thrown under the bus on carried interest, as there are many good reasons why it’s fair and proper. I don’t expect tax reform to deliver tax rates as low as 25 percent, so Republicans should keep fighting to keep separate lower tax rates on long-term capital gains and qualifying dividends. That lower rate affects futures 60/40 tax rates (the 60 percent part) and carried-interest.
Bottom line
Romney’s tax return is like an encyclopedia for tax preparation on sophisticated investors with foreign transactions. Romney may have been worried that pundits would harp on it and cover every nook and cranny. It’s an exercise in proper compliance and it should put them to sleep instead. Let’s move on and address this during tax reform, with Romney perhaps as President. In case anyone, including President Obama questions whether or not Gov. Romney paid his fair share of taxes, who among us can argue that one person should pay more than $10,000 per day?
2012 Update on Foreign Tax Matters:
In accordance with the Hiring Incentives to Restore Employment Act enacted in 2010, the IRS expanded reporting of foreign transactions even more, with its new Form 8938 (Statement of Specified Foreign Financial Assets).
IRS announces third offshore voluntary disclosure program:
The IRS recently reopened an offshore voluntary disclosure program (OVDP) to allow taxpayers with offshore financial accounts (including brokerage accounts, mutual funds, pension plans and life insurance) or assets to comply with their U.S. federal income tax obligations and foreign account reporting requirements. Because the Foreign Account Tax Compliance Act (FATCA) will force foreign banks to divulge information regarding their U.S. clients, U.S. taxpayers have a strong incentive to enter the OVDP rather than risk detection by the IRS. Once the IRS has begun an audit of a taxpayer, the taxpayer is no longer eligible to participate in the OVDP.
The new OVDP will be open for an “indefinite period,” but the IRS could choose to end it at any time.
The new program has no deadline to apply. However, the IRS emphasized that the terms of the new program could change in the future. The IRS stated that, for example, at any time the penalties under the program could be increased.
December 9, 2011
How To Pay Back MF Global Customers 100%
By Robert A. Green, CPA
Green's Forbes blog version.