Lessons from the Mitt Romney and Newt Gingrich Tax Returns

Lessons from the Mitt Romney and Newt Gingrich Tax Returns
by Asher Rubinstein, Esq.

The tax returns of the Republican presidential candidates have been the subject of many news reports and discussion this week.  In these days of high unemployment and economic uncertainty, Mitt Romney has been demonized by his own party and by Democrats for being wealthy and for running a successful investment fund.  Now, he is being criticized over his taxes.

We wish to point out that our comments are in no way an endorsement of any candidate or any political party.  We strive to write about issues of taxation and law, and we do not take a political stance.  With this in mind, we would like to comment on some of the recent news reports.

1.  Romney “has been paying a far lower percentage in taxes than most Americans, around 15 percent of annual earnings”.

This is because most of his income is investment income, taxable at 15% capital gains rate (after they are first taxed on the corporate level), rather than 30+% income tax rate.  This preferential tax rate encourages investment in corporations, new technologies, real estate, etc. and stimulates the economy.  To increase the capital gains tax rate to income tax levels would discourage investment and cause people to park money in, e.g., bank accounts paying very low interest.

2.  “Bain Capital, the private equity partnership Romney once ran, has set up some 138 secretive offshore funds in the Caymans.”

Hedge funds and private equity funds are regularly established in foreign jurisdictions such as Cayman in order to attract investment from non-US persons (who may be reluctant to invest in the US for reasons including high tax rate, State and Federal regulation, etc.).

Cayman funds are not “secretive”.  They are publicly registered, annually reviewed and are subject to KYC, anti-money laundering regulations.  Moreover, Cayman and the US have signed a Tax Information Exchange (TIE) agreement and a Mutual Legal Assistance Treaty (MLAT).

There is no prohibition on a US person from investing in a Cayman fund.  It is not illegal.  So long as the investment is disclosed to the IRS (on the FBAR form) and foreign income reported and tax paid on that income, there is nothing wrong.

There is no tax advantage for a US person to invest in a Cayman fund.  The investment is reported to the IRS, and will be taxed at the same rate as if it had been a US investment.

Even if there was a tax reason to direct investment to Cayman, people and businesses very often chose their course of action, including major decisions, on the basis of tax minimization through geography.  Hedge funds legally move from New York City to Connecticut to save taxes.  Elderly people move to Florida for reasons other than weather.  Howard Metzenbaum, who spent decades of public service as a U.S. Senator, moved to Florida in his final years because there is no estate tax in Florida.

3.  “Unlike most Americans, Mr. Romney has between $20.7 million and $101.6 million in his IRA.”

Romney’s IRA was funded with shares (or partnership interests) of Bain many years ago, when the share prices (or partnership interests) had a much lower value.  Over time, those shares (interests) grew in value.  That is the purpose of an IRA – the tax-deferred accumulation of gains over time.

When Romney withdraws from the IRA, gains will be taxed at ordinary income tax rates (30+%), rather than capital gains rate (15%), even though the gains are technically capital gains rather than income.

Even if Romney does not withdraw from the IRA, when he is 70.5 years old, the IRS will still tax the funds not withdrawn, at income tax rates.

It seems to us that Mr. Romney availed himself of legal opportunities to pay less in taxes.  We are reminded that lowering one’s taxes is neither illegal nor immoral.  On a basic level, people take either the standard deduction or itemize deductions, depending on the more favorable outcome.  There is nothing sinister in this.

Judge Billings Learned Hand (1872-1961), one of the most important federal judges of the last century, wrote:

“Over and over again, courts have said that there is nothing sinister in arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich and poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions.”  (Commissioner of Internal Revenue v. Newman, 159 F.2d 848 (2d Cir. 1947) (dissenting opinion)).

Moreover, Justice George Sutherland (1862-1942) of the United States Supreme Court wrote:

“[T]he legal right of a taxpayer to decrease the amount of… what otherwise would be his taxes, or altogether avoid them, by means which the law permits cannot be avoided.”  (Gregory v. Helvering, 293 U.S. 465 (1935)).

These words establish a clear principal: Tax minimization, through legal means, is not only allowable, it is wise and it is universal.

Newt Gingrich has stated that his tax rate was 31%, in contrast to Romney’s 15%.  It seems to us that Mr. Romney is not only a better investor, he also consulted better tax lawyers.



as seen onbloombergcnbcforbesnytimeswall street