Are Bain and others gaming the system to pay less taxes? If so, is it legal?
More Tax Tricks, Private Equity Style
NYT editorial
Gawker.com was onto something big last month when it raised questions about Mitt Romney’s taxes by putting online confidential documents from Bain Capital, the private equity firm co-founded by Mr. Romney.
As The New York Times reported this week, the attorney general of New York, Eric Schneiderman, has subpoenaed Bain and other private equity firms for documents that could reveal whether they have used abusive tax strategies to drastically cut their partners’ tax bills.
At issue is how private equity partners treat management fees for tax purposes. Such fees, generally 2 percent of the assets they manage, are normally considered ordinary income, like salaries. But through various machinations, several firms routinely re-brand the fees as capital gains from investing, which are taxed at 15 percent, far lower than the top rate of 35 percent for ordinary income.
Is that legal? Is it legal in some instances and not in others? Mr. Schneiderman apparently wants to find out. In the past, the Internal Revenue Service has said that converting management fees into capital gains is an area of “possible noncompliance,” but it is unclear whether the I.R.S. has audited the practice. Some tax experts have argued that the practice is illegal, while others — including those who advise private equity firms — say it is not even aggressive. What is clear is that these tactics come on top of a huge existing loophole that allows private equity partners to pay the capital gains rate on a share of the profits earned by the funds, which comprises the bulk of their income and are separate from their management fees.
The upshot is that private equity partners, the deal makers who have become multimillionaires through debt-driven buyouts of public companies, pay a flat rate of 15 percent on all or most of their earnings, compared with top rates as high as 35 percent for wage and salary earners. If that’s not illegal, it should be.
(More here.)
NYT editorial
Gawker.com was onto something big last month when it raised questions about Mitt Romney’s taxes by putting online confidential documents from Bain Capital, the private equity firm co-founded by Mr. Romney.
As The New York Times reported this week, the attorney general of New York, Eric Schneiderman, has subpoenaed Bain and other private equity firms for documents that could reveal whether they have used abusive tax strategies to drastically cut their partners’ tax bills.
At issue is how private equity partners treat management fees for tax purposes. Such fees, generally 2 percent of the assets they manage, are normally considered ordinary income, like salaries. But through various machinations, several firms routinely re-brand the fees as capital gains from investing, which are taxed at 15 percent, far lower than the top rate of 35 percent for ordinary income.
Is that legal? Is it legal in some instances and not in others? Mr. Schneiderman apparently wants to find out. In the past, the Internal Revenue Service has said that converting management fees into capital gains is an area of “possible noncompliance,” but it is unclear whether the I.R.S. has audited the practice. Some tax experts have argued that the practice is illegal, while others — including those who advise private equity firms — say it is not even aggressive. What is clear is that these tactics come on top of a huge existing loophole that allows private equity partners to pay the capital gains rate on a share of the profits earned by the funds, which comprises the bulk of their income and are separate from their management fees.
The upshot is that private equity partners, the deal makers who have become multimillionaires through debt-driven buyouts of public companies, pay a flat rate of 15 percent on all or most of their earnings, compared with top rates as high as 35 percent for wage and salary earners. If that’s not illegal, it should be.
(More here.)
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