Mitt Romney has benefited from an unlawful tax strategy employed by Bain Capital, three separate tax law experts tell Lean Forward.
“It violates the established tax law,” one put it flatly.
At issue are documents posted online Thursday by Gawker.com. They show that, like many other private equity firms, Bain has reduced its tax bill via an aggressive strategy that converts management fees, which are taxed as ordinary income, into capital gains, which are taxed at the lower 15% rate, tax experts who have reviewed the documents say. The documents show Bain has employed this strategy to convert over $1 billion in fees into capital gains, The New York Times reports.
Romney left Bain some time between 1999 and 2002—the exact date is contested—but there’s no dispute that, through his severance agreement, he maintains a financial interest in the investment funds at issue.
The Romney campaign has said Romney has no control over his investments. “Governor and Mrs. Romney’s assets are managed on a blind basis,” Michele Davis, a campaign spokeswoman said in a statement to The Washington Post. “They do not control the investment of these assets, the investment decisions are made by a trustee. Furthermore, the trustee does not decide where funds he invests in are domiciled, the sponsors of the funds do.”
On his blog Thursday, Victor Fleischer, a prominent tax law professor who teaches at the University of Colorado Law School, explained how the management fee conversion strategy often works.
“Each year, before the annual management fee comes due, the fund manager waives the management fee in exchange for a priority allocation of future profits,” Fleischer wrote. “There is minimal economic risk involved; as long as the fund, at some point, has a profitable quarter, the managers get paid.”
But in order to be legal, there needs to be some chance that the manager will lose out under the new arrangement, Dan Shaviro, a professor of taxation at NYU Law School, and the author of several books on tax policy, explained. And in Bain’s case, Shaviro, Fleischer, and a third prominent tax law professor who asked to remain anonymous all said, there just isn’t enough risk.
“[Bain] managers get to choose whether or not to waive [the management fee] on an annual basis,” Fleischer said. “So they can look at how their portfolio investments are doing on an annual basis and decide.”
“It is in my view improper, and it violates the established tax law,” said the third tax law professor. “In a court of law, I would rather be on the government’s side.”
“It’s just a fancy game with the IRS,” the professor added.
To be sure, the IRS isn’t known to have brought any cases relating to the management fee conversion strategy. Shaviro said that’s because the outmanned agency has been unable to keep up with the slew of sophisticated tax avoidance strategies pioneered in recent years. “They have too much stuff to worry about.”
In a statement to the Times, a Bain spokesman said the documents show "compliance with all laws.” And Fleischer and Shaviro both cautioned that different tax lawyers might come to different conclusions. “It’s conceivable that someone got an opinion that this works,” Shaviro said. “But in cases like this, I think the best, most reputable tax lawyers probably would refuse to give an opinion,” he said, because they would strongly doubt its legality.
On his blog, Fleischer was blunter: “If challenged in court, Bain would lose,” he wrote, and added: “Bottom line: Mitt Romney has not paid all the taxes required under law.”