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

Republican presidential candidate Mitt Romney’s 2010 tax returns and the 13.9 percent rate he paid highlight how wealthy investors can use the preferential treatment of income classified as capital gains and dividends to minimize payments to the U.S. government.

The returns provide a glimpse into the financial life of Romney, whose campaign estimates his fortune 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 the private-equity investments Romney made during his career at Bain Capital LLC. The couple donated about 16 percent of their income to charity.

“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. More than half of the former Massachusetts governor’s earnings were considered 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 yesterday.

“Oh, I’m sure people will talk about it,” Romney, 64, said during a debate in Tampa, Florida, on Jan. 23.

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 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 profit stake that private- equity managers receive from successful investments even if they don’t invest their own money. Carried interest 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. (SPLS) 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 proposals were implemented, including allowing the tax cuts enacted in 2001 and 2003 to expire and taxing carried interest as ordinary income, said Seth Hanlon, director of fiscal reform for the Center for American Progress Action Fund. The Washington research group is 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. The returns show that the Romneys’ trusts received additional partnership interest in Bain funds, and it was unclear exactly why.

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

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, and Democrats are pressing the Romney campaign to provide more returns to give a fuller picture of his income and how it has changed.

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

Better Under Gingrich

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.

Romney’s $7 million in charitable contributions in 2010 and 2011 topped the $6.2 million he and his wife paid in taxes during the period. The couple gave $1.5 million cash in 2010 and $2.6 million cash in 2011 to the Church of Jesus Christ of Latter-Day Saints, the tax documents show.

At first glance, the dollar amount of the Romneys’ charitable giving is “shocking,” Russell James, director of a graduate program in charitable financial planning at Texas Tech University in Lubbock, said in a telephone interview yesterday. “But it’s a different story when you compare it to total wealth. It’s not a shocking amount when you have a quarter- billion dollars in wealth.”

‘Squeaky Clean’

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

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, he 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.

‘Great Technique’

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.”

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.

The tax returns shed no new light on Romney’s considerable individual retirement fund, worth as much as $101.6 million, according to a financial disclosure he filed in August. It’s unclear why the value is so high, given that contribution limits to IRAs are relatively low.

Cayman Investments

Kleinbard speculated that Romney claimed low values on carried interest in various Bain funds that he contributed to the IRA.

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.

To contact the reporters on this story: Richard Rubin in Washington at rrubin12@bloomberg.net; Jesse Drucker in New York at jdrucker4@bloomberg.net

To contact the editor responsible for this story: Jodi Schneider at jschneider50@bloomberg.net

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