A tax strategy once used by the hedge fund Renaissance Technologies is attracting a new level of scrutiny from the IRS.
The government Wednesday labeled the “basket options” strategy of converting short-term capital gains and ordinary income into lighter-taxed long-term gains as a “listed transaction.” That requires anyone who uses it to declare the maneuvers on their tax returns and imposes penalties for those who don’t.
“A listed transaction is, in effect, flagged as a tax shelter by the IRS,” said Steve Rosenthal, a senior fellow at the Tax Policy Center in Washington who testified about the transactions at a hearing last year. “They’re really sort of the worst of the worst that the IRS trips across.”
The notice applies to transactions in effect as far back as
Renaissance’s use of basket options was the subject of a U.S. Senate hearing in 2014. According to the panel’s report, Renaissance probably avoided more than $6 billion in U.S. income taxes over 14 years through transactions with Barclays Plc and Deutsche Bank AG.
The transactions allowed Renaissance to claim that it wasn’t the owner of securities inside the basket options, whose value would fluctuate based on the value of securities chosen by the hedge fund, according to the Senate report.
Renaissance, founded by James Simons, is one of the most successful hedge funds. Its flagship Medallion Fund achieved annual returns, before fees, averaging 71.8 percent from 1994 through mid-2014, according to a public filing.
Last year, Renaissance said it was “comfortable” that its tax treatment was correct and that it expected to prevail in a dispute with the Internal Revenue Service. The firm said then that its decision to use basket options wasn’t driven by the tax benefits.
It’s not clear whether the IRS and Renaissance have resolved their dispute.
Ron Wyden of Oregon, the top Democrat on the Senate Finance Committee, praised the IRS decision to “bring the hammer down” on the transactions.
“The law is very clear in this area -– basket options are a tax shelter,” Wyden said in a statement. “Today’s guidance from the administration is a win for taxpayers and brings us one step closer to a more fair and equitable tax code.”
Converting short-term gains to long-term gains can yield a major advantage.
Under current law, profits from short-term capital gains are taxed at a top federal rate of 43.4 percent, compared with a
23.8 percent top rate for long-term gains. In some prior years, the top rates were 35 percent and 15 percent.
Jonathan Gasthalter, a spokesman for Renaissance, declined to comment. A spokeswoman for Deutsche Bank didn’t comment. Andrew Smith, a spokesman for Barclays, declined to comment.
As of last year’s hearing, both banks had ceased offering the basket options.