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Romney’s 13.9% Tax Rate Shows Power of Investment Tax Preference

February 03, 2012

(For more campaign coverage, see ELECT.)

Jan. 24 (Bloomberg) -- Republican presidential candidate Mitt Romney’s 13.9 percent tax rate in 2010 shows how wealthy investors can use the preferential treatment of income classified as capital gains and dividends to minimize payments to the federal government.

The returns also provide a glimpse into the financial life of Romney, whose campaign estimates the fortune he built in the private-equity industry at between $190 million and $250 million. Romney and his wife, Ann, receive money from blind trusts that invest in hedge funds and receive profits that flow from Romney’s investments at Bain Capital LLC.

“The most affluent Americans in recent years have pulled away from the rest of us, and the reason is at least in part that they are able to compound their wealth at very, very low tax rates,” said Edward Kleinbard, a law professor at the University of Southern California. “Romney’s tax return, with its heavy reliance on income taxed at low capital gains rates, demonstrates that.”

The Romneys earned $21.6 million in 2010 and paid $3 million in income taxes, about the same amount that they gave to charity. The former Massachusetts governor earned more than half his income from capital gains and dividends, which are taxed at a top rate of 15 percent, rather than the 35 percent top rate for ordinary income. His campaign released the returns today.

“Oh, I’m sure people will talk about it,” Romney, 64, said during a debate in Tampa, Florida, last night. “You’ll see my income, how much taxes I’ve paid, how much I’ve paid to charity. You’ll see how complicated taxes can be.”

Near the Top

Romney’s income puts him near the top of U.S. taxpayers. In 2008, according to the Internal Revenue Service, the median adjusted gross income was $33,048, which Romney earned in less than a day. Reaching the top 1 percent of taxpayers required $380,354 in adjusted gross income, about Romney’s earnings in a week.

The Romneys received a $1.6 million refund after filing their 2010 return because they overpaid taxes during the year. They pay estimated taxes and at the end of the year, the tax return reconciles their payments. They had the refund applied to their 2011 taxes.

The campaign also released an estimated tax return for 2011 showing that Romney had an effective tax rate of 15.4 percent on $20.9 million in adjusted gross income. That return hasn’t been filed with the IRS.

Rekindling Debate

The discussion of Romney’s returns has reignited the political debate over the tax treatment of investments and particularly carried interest, or the profits stake that private-equity managers receive from successful investments even if they don’t invest their own money. It is taxed at capital gains rates, and President Barack Obama and many Democrats want to reverse that policy, calling it unfair.

Romney’s 2010 income included $7.4 million in carried interest, said Ben Ginsberg, national counsel for the campaign. Romney, who touts his track record in investing in companies such as Staples Inc. and The Sports Authority Inc., received $5.5 million in carried interest in 2011.

During 2010 and 2011, Romney paid $7.5 million less in taxes than he would have if various Obama tax plans were implemented, including letting the tax cuts enacted in 2001 and 2003 expire and taxing carried interest as ordinary income, said Seth Hanlon, director of fiscal reform for the Center for American Progress Action Fund, a Washington research group often aligned with Democrats.

Ginsberg said Romney has paid 100 percent of what he owes the government.

Just Capital Gains

Romney’s carried interest income stems from his tenure at Bain, which ended in 1999.

“His position on carried interest is that it’s capital gain income and capital gains should be treated as capital gains,” Romney adviser Eric Fehrnstrom told reporters in Tampa today.

Romney’s return indicates that he carried forward $4.8 million in capital losses from previous years, an indication that he didn’t report positive capital gains on his 2009 return. The campaign didn’t release tax returns from before 2010.

“It’s an extensive disclosure and we feel it satisfies” the requests for Romney to release his returns, Ginsberg told reporters today.

Resisting Release

Romney, who lost the South Carolina primary on Jan. 21 and is competing in the Jan. 31 contest in Florida, would fare better financially under rival Newt Gingrich’s tax plan than under his own. Gingrich would end all taxation of capital gains; Romney wouldn’t let high-income taxpayers receive that break.

In 2010, the Romneys took more than $4.5 million in itemized deductions, including almost $3 million in charitable contributions. The couple donated $1.5 million in 2010 to the Church of Jesus Christ of Latter-Day Saints, which also received donations from the family’s foundation. They contributed $2.6 million to the Mormon church in 2011, according to the estimated return.

Romney didn’t take travel deductions related to his income from public speaking, said Ken Brier, a tax attorney in Needham, Massachusetts, who described Romney’s returns as “pretty squeaky clean.”

“He’s gone pretty light on his deductions,” Brier said. “I guess he doesn’t want anyone to question it.”

Gifts to Children

The returns also demonstrate how, using sophisticated estate planning, Romney has been able to give millions of dollars to his children free of estate and gift taxes, because of a legal structure known as a “grantor trust.”

Romney established three trusts to which he contributed assets. The campaign said his children were listed as beneficiaries, though didn’t specify of which trusts. The income generated by the trusts triggers a tax obligation for Romney. By picking up that tax bill, Romney found a legal way to transfer money to his children free of gift taxes, said Mark G. Bosswick, managing partner at Berdon LLP, an accounting firm in New York.

In addition, any appreciation of the stock after it was donated to the trusts grows free of gift and estate tax, assuming a gift tax was calculated at the time of the donation. The estate tax won’t be applied to the appreciation of assets that are no longer in his estate.

“It’s a great technique because not only are you doing the initial gift, but by him paying the taxes on the trusts’ income each year he’s making additional gifts to the trust beneficiaries free of gift tax,” Bosswick said. “Plus, any appreciation of the investments will not be subjected to estate and gift tax.”

AMT Activated

It’s unclear if any of the trusts were “revocable,” he said, which would mean the money would go back to Romney and negate the tax benefit.

The Romneys paid $232,989 because of the alternative minimum tax, which is designed to prevent people from avoiding taxes legally. That parallel tax system doesn’t eliminate the preference for investment income.

Anthony Nitti, a tax partner at WithumSmith & Brown in Aspen, Colorado, who works with high-income clients, said the Romneys’ trusts have investments in such places as the Cayman Islands. Even if they didn’t make those investment decisions, he said, “there’s some sophisticated tax planning going on.”

The 2010 return shows that the Romneys’ blind trusts have invested in an array of funds in tax-favored jurisdictions, including the Caymans, Ireland and Luxembourg. Such offshore funds attract investments from overseas investors who don’t want to file disclosures with the IRS, said Bradley Smallberg, a CPA at Smallberg Sorkin & Co. LLP in Melville, New York.

Fully Taxable

Brad Malt, a partner at Ropes & Gray LLP in Boston who operates the family’s blind trusts, said those funds and the Romneys’ profits from them are fully taxable and fully reported.

“When we make an investment in a Cayman fund, we’re presented with investment documents,” he said. “The sponsor has already chosen where the fund is to be organized.”

The Romneys had a bank account in Switzerland, the return shows. The account for one of the trusts at UBS AG held about $3 million and it has since been closed, Malt said.

Malt, who began working as the Romneys’ trustee in 2003, said during that time he was unaware of any IRS audit of the couple’s tax returns.

--With assistance from Hans Nichols and Steven Sloan in Washington, John McCormick in Chicago and Elizabeth Ody in New York. Editors: Jodi Schneider, Mark McQuillan.

To contact the reporters on this story: Richard Rubin in Washington at; Jesse Drucker in New York at

To contact the editor responsible for this story: Jodi Schneider at

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