Offshore IRA

An offshore IRA is a tax ploy used by the ultra-wealthy to invest in foreign partnerships and hedge funds using debt (leverage), investments prohibitively expensive for a conventional IRA. Also, unlike most conventional IRAs, an off-shore IRA may investment in gold, silver, foreign currencies, private stock, and foreign real-estate.

A substantial portion of Romney’s wealth, between $20.7 million and $101.6 million, is held in several offshore (Cayman Island) IRA accounts, producing between $1.5 million and $8.5 million in income over a 19 month period.

UBI and Blockers

An IRA that invests in debt-financed entities is subject to the “unrelated business income” (UBI) rules. UBI is taxed at 35% federal and requires detailed reporting.

To circumvent UBI, an offshore “blocker” corporation is formed, the IRA invests in the blocker corporation which, in turn, owns the entity generating UBI.

Because the IRA did not invest directly in UBI-producing entity, it escapes the tax. Although not illegal, blockers cost the Treasury nearly $1 billion a decade.

Defective Grantor Trust

Romney also created a “intentionally defective grantor trust,” which shifts wealth to his five sons in a tax efficient manner. The trust is now valued at $100 million.

Romney transferred assets to a trust for his children, but he continues to pay taxes on the income generated by the trust. The tax payments are not considered additional gifts to the children and upon death, the trust assets are not considered part of either Mitt or Ann Romney’s estate for estate-tax purposes.

Carried Interest

While either Mitt or Ann Romney is alive, the trust for the children grows tax-free — the trust income is accumulated and added to principal for the benefit of children and descendants without the trust paying taxes.

Example

Assume Romney held $100 million in investments generating $5.0 million in dividends and long-term capital gains. If he gifted the $5.0 million directly to his children, he would pay income taxes on the income (assume 15% federal) and would be liable for gift taxes as well (assume 35% federal).

Instead, by using an intentionally defective grantor trust, Romney pays no gift tax on the $5.0 million, thereby saving $1,750,000. He pays income taxes of $750,000.

In 2010, Romney donated $1.46 million in stock to his private foundation, the Tyler Foundation.

Instead, by using an intentionally defective grantor trust, Romney pays no gift tax on the $5.0 million, thereby saving $1,750,000. He pays income taxes of $750,000.

Introduction

Under political pressure, presidential candidate Mitt Romney reluctantly released his 2010 federal income tax return. His gross income was an eye-popping $21.6 million, although his tax bite was $3.1 million, or about 15% of his adjusted gross income.

Romney used a variety of controversial, but currently legitimate, tax breaks to lower his payroll and income taxes below the average percentage paid by workers earning $50,000 – $100,000.

2010 Income Tax Return

Romney’s tax return contains $21,646,000 of adjusted gross income, $4,500,000 of itemized deductions, mostly charitable deductions and state income taxes, taxable income of $17,127,000 and a tax of $3,106,000.

He earned $540,000 in speaker’s fees and another $114,000 in director’s fees from the Marriott corporation. His tax return runs 203 pages, including 67 pages of supplemental attachments.

Miscalculations

Romney’s tax returns are so complicated that he overpaid about $44,000 in taxes, because his accountants incorrectly calculated the gain on the sale of Goldman Sachs stock, according to the New York Times.

His accountants used a $9,800 basis in the calculation of a stock sale for $286,500 when the actual basis was closer to $316,000; in fact, there should have been a capital loss of about $20,000.

Carried Interest

Unlike doctors, lawyers, plumbers and teachers, all of whom pay taxes at ordinary income rates, those managing investment partnerships and hedge funds are taxed on their personal services at 15%, the long-term capital gain and corporate dividend rates.

This is because they claim that they are investors in the enterprise and receive a percentage of the partnership, rather than individuals performing personal services.

Romney’s ability to characterize his participation in the various Bain Capital investments as carried interest help lower his tax rate to 15% federal. Approximately 73% of his gross income was classified as carried interest.

Stock Donation

Romney donated appreciated stock to charity and received a charitable deduction at the full fair market value of the stock. The gain on the appreciation goes untaxed.

In contrast, if he were required to sell the stock and pay the tax, the charitable deduction would be reduced by the amount of tax paid.

In 2010, Romney donated $1.46 million in stock to his private foundation, the Tyler Foundation.

Operating a private foundation has a distinct advantage: contributions are deducted in full, but the funds can remain in the foundation for future distribution to charity. In contrast, those without private foundations must make full payment directly to a charity to claim a deduction.

Charitable Deduction

In a potentially embarrassing admission, Romney contributed to the Mormon church $1.525 million or about 7.2% of adjusted gross income, instead of the tithe of 10% that is required.

In contrast, on his 2011 tax return, he donated the full 10% of his adjusted gross income, which suggests that he shorted his church about $640,000 in 2010 and could be the real reason why he resisted releasing his return.