Investigation Will Put Romney's Time At Bain Under Further Scrutiny
Republican presidential nominee Mitt Romney's time at Bain Capital will come under further scrutiny after the New York attorney general began an investigation into the tax practices of major equity firms, according to The New York Times.
The attorney general, Eric T. Schneiderman, who is a Democrat, has been looking into whether the firms, including Bain Capital, have used loopholes to keep hundreds of millions of dollars meant to be taxed.
According to Reuters, U.S. tax authorities did not act on an investigation that began five years ago.
Schneiderman subpoenaed tax documents from at least a dozen firms to see how the companies managed to reduce their tax bills.
According to John J. Barcal, an associate professor of accounting at the University of Southern California, the 1935 Supreme Court decision in the Gregory v. Helvering case detailed an American right to find ways to pay as few taxes as possible.
"Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury," said Judge Learned Hand. "There is not even a patriotic duty to increase one's taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands."
Barcal also mentioned an April New York Times article that detailed how Apple sidesteps billions in taxes.
Apple's response to its tax practices, published in The New York Times the same day, highlighted ways it had created hundreds of thousands of jobs and claimed to pay $5 billion in taxes.
Reuters said that Schneiderman is looking at "management fee waivers" that private equity managers use to convert parts of their pay into investment income, which reduces the tax rate on that pay to 15 percent.
Fortune breaks down the controversial maneuvering involved in management fee waivers:
In short, private equity funds receive annual management fees that are used to cover overhead like salaries and office leases. Typically 2% of capital commitments, paid by fund investors (pension funds, endowments, etc.). Certain firms like Bain Capital, however, sometimes "waive" (i.e., redirect) the management fees directly into the funds -- in lieu of certain co-investments that are required of firm executives. And if those funds make profit for the waived year, the firm executives get to pay capital gains tax rates that are substantially lower than ordinary income rates. As for covering overhead, Bain taps management fees from non-private equity funds (hedge funds, venture capital funds, etc.).
And later, Fortune says that Romney received a percentage of all Bain Capital commitments, regardless of individual fund waivers and instead of being privy to a portion of management funds from each Bain fund.
In other words, imagine that Bain Capital is currently managing $20 billion in fund commitments across its entire universe of strategies. And then imagine that this includes $10 billion of private equity fund commitments, on which Bain Capital waived fees for 2012. Romney still would be entitled to his cut based on the $20 billion figure, not on the $10 billion figure. And he should be paying taxes on that money at an ordinary income rate.
According to Fortune, though Romney paid a much lower tax rate (14 percent) than many other Americans, he probably paid a higher rate than his former Bain colleagues.
Whether or not Bain's tax avoidance activities prove to be legal, Romney's ties with the company will be fodder for Barack Obama's campaign, which has sought to paint Romney as an excessively wealthy, selfish American businessman.
Romney was CEO of the company during the time under investigation, and has come under fire recently for refusal to release too much of his tax returns.