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. Romney has three years to amend his original return to claim the $1.75 million unreported charitable contribution.] 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.  See Charles I. Kingson, Did Romney Violate the Jurat?, 137 Tax Notes 107 (Oct. 1, 2012)].  In Rev. Rul. 67-460, the IRS refused to allow a taxpayer to manipulate his charitable deduction in this manner. [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…”.]

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. The blind trust is “blind” in name only. It does not meet the federal blind trust requirements], 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. 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.].  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. [4. The PALs were claimed on Form 8582 and could be used to offset future income.]

    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.

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. Note: Romney 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], 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.