GreenTraderTax Blog
GreenTraderTax
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.