ROMNEY’S 2011 TAX RETURN

Introduction

    Mitt and Ann Romney’s 2011 income tax return reveals that $6.0 million (44%) of their Adjusted Gross Income (“AGI”) came from foreign investments, $4.5 million of which received a favorable capital gains preference.

     Because tax filings are confidential, the public release of Romney’s 2010 and 2011 tax returns offer a rare opportunity to analyze how the richest Americans structure their investments to reduce their effective tax rate far below the average percentage paid by middle-class workers.  Romney’s 2011 return contains several interesting and potentially controversial issues. See the attached spreadsheet analysis.

Cooking the Numbers

    Romney reported $13.7 million of AGI, although an earlier version of his 2011 tax return showed AGI of $20.9 million.  So how did $7.2 million disappear from his tax return?  His charitable deductions dropped from $4.0 million to $2.25 million 1 for political reasons: he wanted his tax rate a minimum of 14%.  If he reported the original $20.9 million and the full charitable deduction, the rate would drop to between 4-6%.

     By failing to report the full deduction, Romney may have violated the sworn statement accompanying his signature:

Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete. [emphasis added]

   Obviously, filing a tax return that deliberately leaves off $1.75 million of charitable deductions is not a true, correct and complete tax return.  2.  In Rev. Rul. 67-460, the IRS refused to allow a taxpayer to manipulate his charitable deduction in this manner. 3

Alternative Minimum Tax Issues

      Romney paid $647,512 in alternative minimum tax (AMT). In 2010, he paid $232,989 for a total of $880,501 for both years.  His tax reform proposal eliminates the AMT and would have saved him $880,000 for 2010 and 2011.   Assuming he paid an average of $440,000 AMT per year, the savings over a 10-year period amounts to $4.4 million.  Absent payment of the AMT, Romney’s tax rate would have been $13.27% in 2009 and 9.79% in 2010, or an average of 11.92%.  Romney’s position on AMT directly affects his tax liability, another reason why presidential candidates should release a decade’s worth of returns.

Marriott Director Payments

     Romney received director’s fees from Marriott of $260,000 in 2011, even though he announced his candidacy for presidency in June.  Did he remain on the Marriott payroll while running for president?  In 2010, he earned $110,000.  Why did he earn 2.35 times the fee in 2011 while working just half the year?

Payroll Tax Inclusion

     Brad Malt, Romney’s personal attorney who runs his blind trust 4, claimed that Romney paid 14.1% in “income” taxes in 2011 per his tax return.  This is misleading:  Malt included $23,179 in self-employments taxes (these are payroll taxes, not income taxes).  The true percentage of income taxes paid to the U.S. was 13.77%.  More importantly, this attempted sleight-of-hand demonstrates why a full review of past returns is needed.

 Church Contributions

     Romney is supposed to donate (tithe) to his church (the Church of the Latter Day Saints) 10% of his income.  His 2011 tax return shows AGI of $13,696,951, but his church contribution was $1,115,489 or 8.14% of AGI, not 10% 5.  On his 2010, return, he gave just 7.2% percent to his church.  His failure to meet his tithe requirement could be a major reason why Romney refuses to release earlier tax returns.

 Rafalca – The Dancing Horse Deduction

     In 2010, Ann Romney her occupation as homemaker.  Yet, Romney claimed passive activity losses (“PALs” — permitted only if one has an active business, rather than a hobby) for Rafalca – their dancing (dressage) horse. The horse endeavor, Rob Ron Enterprises, LLC, earned $50 in 2010, but Romney claimed $77,731 in losses. 6

    Ann was not involved in an active business, since her occupation was homemaker and Mitt has stated several times he has nothing to do with the activity.  Rob Ron Enterprises, LLC does not appear on his 2011 return.  In fact, of the $2.275 million in unused PALs claimed in 2010, only $320,000 were reported in 2011.

    What happened to the $2.0 million in unused losses that somehow dropped off the 2011 return, including Rafalca?  This suggests that $2.0 million in PALs claimed in 2010 could not survive IRS scrutiny.

 Conclusion

    Even with the whole world watching, Romney’s 2011 tax return raises multiple controversial issues.  Forty-four percent of his income is traceable to foreign sources. The income and deductions may have been manipulated for political purposes, in violation of his sworn tax return statement.  Whether he stiffed his church is, of course, between him and his church, but it appears that he did.  Why did Mr. Malt include payroll taxes in his calculation of income taxes and was this “mistake” repeated in previous years to boost Romney’s tax percentage paid?

   More troubling is his connection with Marriott Corporation and whether he continued on its board after his presidential announcement.  If not, then why was his 2011 directors’ fee $150,000 more than in 2010?

    Finally, why did he ditch $2.0 million of accumulated PALs claimed in 2010, including the losses attributable to Rafalca?

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Footnotes

  1. Romney has three years to amend his original return to claim the $1.75 million unreported charitable contribution.
  2.  See Charles I. Kingson, Did Romney Violate the Jurat?, 137 Tax Notes 107 (Oct. 1, 2012)
  3. Id. See: Rev. Rule 67-460, which involved a taxpayer not claiming a full charitable deduction to meet certain requirements under the tax code.  The IRS held: “… the full amount of the taxpayer’s charitable contributions must be taken into account in computing his income tax liability. It is not permissible in such computations to take into account only a portion of the actual charitable contributions for the purpose of increasing the income tax liability thus computed…”.
  4. The blind trust is “blind” in name only. It does not meet the federal blind trust requirements
  5. Note: AGI was used by Romney’s CPAs to calculate his average charitable donation as a percentage of income. so AGI is the proper measurement for this issue.
  6. The PALs were claimed on Form 8582 and could be used to offset future income.
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Romney’s 2011 Income: 44% from Foreign Investments

New Disclosure Form

Starting in 2011, taxpayers with overseas and other financial investments were required to report those assets on Form 8938.  Because of this new reporting requirement, we learned that of the $13.7 million in adjusted gross income earned in 2011 by Mitt and Ann Romney, $6 million (44%) was traceable to foreign investments.

 Huge Tax Break

According to his Form 8938 disclosure, Romney received $4.5 million in foreign capital gains 1, taxed at 15% federal and $1.5 million in foreign dividends.  Using a typical dividend return rate of 2-3%, this would indicate between $50 million and 75 million invested overseas.  In addition, $6 million in cash was held in foreign entities.

 No Policy Rationale

What is the tax policy rationale for allowing favored capital gains rates on gains earned on foreign investments?  How does this tax break create wealth and jobs in the U.S.?  Of course, the answer is that politics, not rationale tax policy, governs this undeserved and harmful tax break that serves no purpose other than to divert needed tax dollars into the pockets of the ultra-rich.

 Conclusion

So now we have a presidential candidate who earned almost half his income from foreign investments and received a substantial tax break in the process. The solution: eliminate the 15% federal capital gains tax rate for foreign investment income, as well as other loopholes exploited by foreign hedge funds and investment partnerships.

  1. Note: Romeny had $9 million in capital gains and 2.3 million in U.S.-source capital losses, providing a net capital gain of $6.7 million, $4.5 million of which were foreign gains
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The Bain Files – The Fee Waiver Ploy

Introduction

On August 23, 2012, the Gawker website released more than 950 pages of confidential Bain Company documents, illustrating how Mitt Romney’s former company games the tax system.  When Gawker released the documents, Forbes magazine smugly announced that it had the same documents and they were “worthless.” Oh, really?

Transformation

Catching the attention of tax professionals was $1.0 billion in professional fees, usually taxed as ordinary income (maximum federal rate 35%), that were magically and improperly transformed into long-term capital gains (15% federal tax rate), thereby saving $200 million in taxes.  The tax ploy has been questioned by Victor Fleischer, a noted expert on fee waivers. 1

Fee Waiver

The Bain fee conversion tax-dodge rests on the dubious premise that partners providing services to a partnership can choose whether to receive compensation income earned and owed to them or waive it, thereby transforming the fees into additional partnership equity taxed as capital gains.

Carried Interest

The Bain technique involves a distortion of the “carried interest” rule, currently under fire in Congress as an abuse.  The carried interest concept is derived from a quirk in partnership law.  Partners are considered co-owners, not employees, of the partnership, although they provide personal services indistinguishable from any other employment relationship.

Thus, partners who commute full-time to the same office, work 60-80 hours a week under the direct supervision and control of their supervisors, and receive compensation for personal services, are not considered employees of the partnership.  As owners, they may receive a profits interest (the “carried interest”) in the partnership in exchange for rendering personal services without immediate taxation. 2

Fee Waivers

However, there is nothing in the carried interest exception that suggests a voluntary waiver of fees already earned and owed is permissible.  In fact, IRC Section 707(a)(2)(A) was enacted to disallow transactions that lacked economic risk.

Because the Bain partnerships were earning income or were profitable, there was little or no actual risk economic risk to the partners who waived their fees; therefore,  the attempted fee waiver failed and the partners were immediately taxable at ordinary income rates on the fees.

 Conclusion

Bain’s fee-waiver gambit was invalid and its partners owe an additional $200 million in federal income taxes on the $1 billion in fees they received. 3

  1. Fleischer, stated that, “If challenged in court, Bain would lose. The Bain partners, in my opinion, misreported their income if they reported these converted fees as capital gain instead of ordinary income.”
  2. This interest is sometimes called “sweat equity.” IRS permitted the carried interest concept in Revenue Procedure 93-27, but it only applied to receipt of a profits interest in the partnership and not to the waiver of earned management fees.
  3. Note:  The New York Attorney General is investigating fee waivers by Bain and other major private equity firms.
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