Sometimes What We Publish Actually Matters

A bold statement!  Catch your breath and savor it (the statement, not your breath).

Some of you may be following the developing issue surrounding the dubious (and profoundly piggish) tactic indulged in by many private equity fund managers of avoiding (evading?) hundreds of millions of dollars in taxes on the management-fee portion of their compensation.  The strategy involves "waiving" the management fees--except they're not really waived, they're "invested" in the fund or a related vehicle and paid to the manager later.  So instead of paying the 35% ordinary income rate on the management fees, these Masters of the Universe pay the 15% capital gains rate--and pay it years after they earned the management fees.  The amounts involved are staggering.  Bain Capital alone has engaged in this tactic as to over $1 billion (yes, with a "B") in management fees, resulting in over $200 million in unpaid taxes from this company's personnel alone.  And this for people already taking home tens of millions of dollars a year after taxes.

New York Attorney General Eric Schneiderman has issued subpoenas to explore how many New York residents may have stiffed his state's treasury in this fashion.  The New York Times reported on it over the weekend here.

The Times' interest in what might be considered an abstruse tax issue is fueled in siginficant part by Republican Presidential Nominee Mitt Romney's longstanding relationship with Bain Capital, and the possibility that he personally benefited from these tactics either while he was actively working there, or as part of the "retirement" package he received when he left.  Unlike every presidential candidate in recent memory, Romney has famously refused to disclose his tax returns except for the last two years, fueling speculation that he is either a tax cheat or at the least the beneficiary of what are referred to in polite company as "aggressive" tax strategies available only to the superrich, resulting in his paying effective tax rates that are a fraction of ordinary working folks'.  (It is worth noting that not every private equity fund played this game.  A number of the most prestigious and successful funds, including Blackstone and Carlyle, reportedly eschewed it.)

Romney supporters deride Attorney General Schneiderman's investigation as politically motivated, and Schneiderman is in fact a Democrat reportedly with ties to the Obama administration.  Why that should discredit the inquiry whether a major-party candidate for President has underpaid his taxes by millions in the midst of an economic crisis--an inquiry that the candidate could resolve simply by disclosing to the electorate the same information every major party candidate for President has disclosed for decades--remains a riddle to me, but perhaps I lack vision.  To be fair, a Romney tax advisor represented categorically to the Times that "Governor Romney's retirement agreement did not give [his] blind trust or him the right to [engage in the fee-waiver strategy], and I can confirm that neither he nor the trust has ever done this, whether before or after he retired from Bain Capital."  The irreducibly concrete among us may be forgiven for preferring show to tell, but again I perhaps lack vision.

This is all very interesting, Bernie, I hear you say, but you drew me into this rather dismal lesson on federal tax policy on the premise you would show how the academic work I publish actually might matter.  Fair enough:  Prepare to be exhilarated.

The Wall Street Journalreports today (sub. req'd) that "a person familiar with [the NY AG's] office's thinking" has explained that the subpoenas were issued in July, before this issue sprang into public consciousness, and were raised by the office's taxpayer protection bureau (a bureau that apparently protects the taxpayers who do pay their taxes by pursuing the ones who don't) based on discussion of the issue in (wait for it . . .) "academic papers."  I would be remiss if I failed to point out that this phrase in the online report is hyperlinked directly to my brilliant and perspicacious colleague Gregg Polsky's 2009 paper describing and condemning this very strategy, Private Equity Management Fee Conversions, 122 Tax Notes 743 (2009) (ssrn here).

So sharpen your nibs, my friends--real regulators may rely on your work to brook the high and mighty.  And of course your mom likes it too.  Hats off to Gregg Polsky for making himself useful!

--Bernie

Comments

[anon]

"Why that should discredit the inquiry whether a major-party candidate for President has underpaid his taxes by millions in the midst of an economic crisis--an inquiry that the candidate could resolve simply by disclosing to the electorate the same information every major party candidate for President has disclosed for decades--remains a riddle to me, but perhaps I lack vision."
Or, the facts.
See, http://www.taxhistory.org/www/website.nsf/web/presidentialtaxreturns
See also, http://www.citizensforethics.org/index.php/press/entry/crew-urges-presidential-candidates-to-disclose-tax-returns/

[anon]

Note also the libel that taxes were "unpaid." That outrageous accusation is refuted in the FIRST PARAGRAPH of the Polsky article cited:
"Because of the uproar over "carried interests," it seems that almost everyone knows that the tax law currently ALLOWS (emphasis added) private equity managers to pay capital gains taxes on a substantial part of the (often substantial) income generated by their services. While this result raises significant tax policy concerns, the basic tax law governing carried interests is well-settled, and legislative action therefore would be necessary to address these concerns."
One supposes that a blogger is entitled to call others "profoundly piggish" without revealing his own tax returns, income, life-style choices, etc. But, as the calls for civility show, the sort of twisting and name-calling that goes on just cheapens the debate.
Make the point about changing the tax treatment of earnings. Make the point about disclosure (which oddly echoes arguments I heard from teh other side about the "ease" of disclosure).
But, making factual arguments and refraining from name-calling makes sense to me.

[Bernie Burk]

Thank you, anon, for jumping into the discussion. Feel free to identify yourself at any point. As for your last commment, I'm afraid that you've flatly misunderstood the tax issue presented, as well as Professor Polsky's article.

Let me try to help: Private equity fund managers get (possibly in addition to others) two completely different categories of compensation. One is called a "carried interest," and is measured by asset value in and performance of the fund. This is the portion of fund managers' compensation whose tax treatement is well settled, and is the subject of your quote from Professor Polsky's article. "Carried interest" compensation is subject to capital gains treatment. There are serious arguments that this is bad policy, but it is clearly the law. It also has nothing to do with my post, and is not the subject of Professor Polsky's article.

Completely separate and apart from "carried interest," most fund managers are also entitled to receive "management fees." These are fees that are paid to them for their services in managing the fund. They are just like the salary or wages you presumably receive for whatever work you do. If paid as management fees, they are subject to taxation at ordinary income rates, just like your salary or wages. But some fund managers engage in what Professor Polsky (who is a national authority on federal income taxation), I, and many other people consider a reprehensible tax dodge, which is to purportedly "waive" those management fees. Except that they don't really "waive" them--they take the money they would have received, and put it into the fund or a related investment. This would be like your instructing your employer to take the salary you would be paid next payday, and instead buy you some stock with it. It would be absolutely clear in these circumstances that you had been paid on payday, and then made an investment; and because you had been paid that day, you would have to pay taxes on your pay as of payday. But fund managers have taken the position that they don't have to pay taxes on their fees for services the way that you do. Instead, they pay capital gains rates that are less than half the ordinary income rates, and pay them years later. You and I don't get to do that. The result is literally hundreds of millions of dollars in UNPAID TAXES--taxes that regular folks like you and me similarly situated have to pay, and that these taxpayers claim they don't have to, and don't, pay.

So yes, I think it's piggish. And yes, I think it is accurate to call the taxes that these individuals don't pay "unpaid taxes."

As for your first comment, I appreciate the argument that some presidential candidates have not disclosed multiple years' tax returns. For the actual nominees of their parties (which is what I was referring to, albeit perhaps less clearly than I should have), that proves to be quite unusual over the last 20 years based on the materials to which you linked.

And more importantly, now that this very distasteful tax dodge regarding "waiver" of fund management fees has come to public attention, it is in my opinion the height of hypocrisy for a presidential candidate's tax advisor to take a public position on behalf of the candidate about what taxes he did or didn't pay--thus conceding that it is a legitimate matter of public and electoral interest what taxes the candidate did or did not pay--and then refuse to prove it by disclosing the actual returns because that's just none of the public's damn business.

I hope this helps you understand the basis for my reasoning and opinions.

--Bernie

[anon]

Thanks for your "help." At least the debate is now, in part, on the merits.
However, you have seized on a putative distinction in my phrasing that is not especially relevant I think.
Polsky stated:
"In a management fee conversion, a portion of future management fees is waived by the management company. In exchange for this waiver, the general partner receives an
increased interest in the fund’s profits. To contrast this increased interest created by a management fee waiver from the 20 percent carried interest, the increased interest will be
referred to as the “additional carried interest” while the 20 percent carried interest will be referred to as the “basic carried interest.”
Mea culpa. I should have referred to the "additional carried interest," though in political discourse it is usually the "carried interest" treatment that is rebuked, and the distinction is not a fine as yours and Polsky's.
See, e.g., http://www.washingtonpost.com/blogs/ezra-klein/wp/2012/08/15/what-is-the-carried-interest-loophole-and-why-doesnt-romney-want-to-close-it/
Although I readily concede that you intended to refer management fees as additional carried interest rather than carried interest (though I haven't checked your math) I maintain that it is libel to make a claim of "unpaid taxes" based on this treatment. You are entitled to your opinion, but, in these circumstances, your claim amounts to a charge of tax evasion.
Polsky's article is chock full of words like "would" and "could" and "should." Anyone reading the article would not come away with the conclusion that Polsky claims that this issue is as clearcut as you do.
I appreciate that you have admitted that your hyperbolic claim that one candidate has not disclosed "to the electorate the same information every major party candidate for President has disclosed for decades" was simply false. Accusations like that cheapen the discourse, right?
As for "show and tell" again, this sounds like a very well-worn political gambit. Some candidate chooses to withhold information deemed "private" or "not relevant" and away we go. I find the claimed outrage is usually on the part of folks who quickly forget that claim when the shoe is on their candidate's foot. Sure, everyone can demand everything. But I don't think that it is that unusual or outrageous for a candidate to draw lines and defend them, or that, once having done so, that candidate can never again speak to the issue. This is, I would agree, a matter of opinion. I am not versed in your previous opinions on such matters, so I will guess that you have been consistent.
Finally, calling names is just unseemly. "Piggish" is an especially loaded term, and cannot be made by any person very blessed in this society when compared with others.
Again, in my view, it is just unseemly to reduce a good argument about the tax treatment of additional carried interest to a low level by engaging in partisan name-calling.
I hope that helps you to understand the basis for my reasoning and opinions.

[Bernie Burk]

Seriously, anon? Let me gently suggest a deep cleansing breath.

Your earlier post quoted Professor Polsky's article selectively to make it sound like it flatly contradicted my post and stated that the specific tax tactic I was criticizing was accepted as perfectly legal by the author himself, On that basis, you called my post "twisting," "outrageous" and a "libel," and then complained that "calling names is just unseemly." Wow. Deep breath, my friend.

You don't even attempt to argue that the tax tactic in question is actually proper (other than the complete misreading of Prof. Polsky's article that you've now wisely abandoned). You just dislike the strong terms in which I've condemned it. I'll leave the irony of your dislike of my colorful language aside. It's a fully appropriate expression of my sincerely held opinion--one that is well grounded in fact and law--to conclude that a tax reporting position that is viewed by a number of leading authorities as unsupportable and allows very rich people to withhold hundreds of millions of dollars in taxes is "piggish" and results in "unpaid taxes."

And even if the tax position were (contrary to good reason) merely a ticket in the audit lottery, or just hyperaggressive, it is legitimate to question whether, at a moment when there is pointed national debate about whether the wealthy are paying their fair share of the cost of our national government, a candidate for President (along with hundreds of multimillionaires) should be playing fast and loose with their tax obligations. I personally care whether the people seeking my vote pay their fair share, and I think that millions of other Americans do too. You don't have to agree with me, but I don't imagine you consider the view outlandish. Feel free to correct me if I've guessed wrong.

What's more, Mitt Romney knows that the fee-waiver tax tactic stinks, and that it would disgust millions of voters if they learned he had done it. That's why he authorized his tax advisor to deny to the New York Times that he engaged in the practice. My criticism of that gambit is not, as you suggest, about being in favor of disclosure for your adversary but not yourself. As I previously stated, it is about the hypocrisy of publicly asserting that your taxes are private and not the public's business, and then making representations to the electorate about what you did or did not do with your taxes. Either you talk about your taxes because they're relevant to the public debate, or you don't because they're not. You can't have it both ways.

Thanks for your efforts to explain your reasoning and opinions. I think I understand them.

Postscript: While I question whether it would be good for your public image (oh wait, you've insisted on remaining anonymous) or your sense of well-being to comment again, feel free to have the last word if you insist. This isn't going anywhere useful.

--Bernie

[anon]

Bernie: Perhaps you should be speaking tonight at the Convention, and not in a blog post.
As for being anonymous, I have seen the way that folks react on this blog when someone disagrees on a point of politics. I prefer not to go down that route. I can think of a prof who is frequently viciously set upon by a pack of angry comments because he is perceived as being the “other side” politically (I don’t know if he is or isn’t).
Attacking me personally would do nothing to advance your argument. Your implication is that what I say in wrong because you can’t attack me by name. That isn’t a good argument. You could always do as Leiter does, and require names to post comments, if you feel that strongly about anonymous comments.
You are right that I believe the tax treatment of additional interest expense to be a legitimate issue.
And, I conceded that the "additional carried interest" to which you putatively referred was not the "basic carried interest" that I quickly read it to be. You appeared, like the national media, to be using "carried interest" as a punching bag. Unlike you, however, I have offered a mea culpa concerning this mistake (quoting from the article on the distinguishable (but much more frequently made) point.) That mea culpa was without benefit and for naught, it seems, as you continue to beat that dead horse.
In any event, as I said, there is really of no great moment to this error. No more, for example, than the importance of your misstatement about past release of tax returns, which you have not acknowledged.
I skimmed the Polsky article in question. If you believe that it provides ample, established legal authority supporting Polsky's "should" argument on the treatment additional carried interest, then I would suggest that you haven't read it carefully enough. A brilliant reader like you couldn't have come to that conclusion, because Polsky doesn't base his argument on established legal decisions, but rather on an interpretations of code provisions that he characterizes in the conditional. His approach apparently hasn't been accepted to date. So, your point that all this is quite clear is not well-taken, in my view.
That is the reason I believed it to be libelous to claim non-payment of taxes in these circumstances. You are now making clear what you meant to say. Now, your argument is not only hyperbolic, but far less persuasive, in my view, because you aren't arguing the merits of the tax treatment of "additional carried interest." Instead, you are arguing the fairness of the tax code. That is just politics, not law. It is fair to argue politics; it is not fair to label persons tax cheats because you think the tax code isn’t fair.
As for other words you lifted out of my comments, you are just sort of conflating issues and running on. As to words “twisting” and “name-calling,” I had in mind a very privileged person calling someone else “piggish” … When a Duke starts complaining about the privileges of royalty because he doesn’t like what the Earl is doing, I find it sort of risible. I didn’t name you in this; as I said, I can’t speak to your personal situation, I really can’t. But, I do know wealthy, privileged persons who have made loads of money and used tax accountants for decades to take every advantage they could who complain about similar issues. As I said, this is risible. Hypocrisy abounds - just like the hypocrisy of politicians who demand disclosures while resisting demands for disclosure.
Thanks again.

[andy]

"-they take the money they would have received, and put it into the fund or a related investment. This would be like your instructing your employer to take the salary you would be paid next payday, and instead buy you some stock with it. . . It would be absolutely clear in these circumstances that you had been paid on payday, and then made an investment."

Is that what happens? My understanding was that only potential future fees could be waived for potential future allocations, whereas in your analogy, the worker gives up salary that he "*would* be paid next payday" in exchange for sure investments.

In the fee waiver context, the fiscal quarter method may greatly increase the likelihood that the manager will receive a priority allocation, but it's still not a plain vanilla constructive receipt case. I suspect that any court case addressing this issue will thus focus on how sure-fire the future allocation would be, and (however it turns out), I'm skeptical that a court would conclude that it's a clear-cut case.

I ditto anon's concern that the "profoundly piggish" comment fails to advance the debate, but this is a blog post, and it is election season. If someone wants well-informed analysis of the relevant issues and a thoughtful critique of the claimed tax treatment, he should look at Polsky's article, which avoids porcine references.

[andy]

Also, Professor Polsky can of course speak for himself, but after I read the article, I did not understand him to be offering slam-dunk arguments. Polsky makes the best case for each of the 3 potential lines of attack, but none is clear cut, as he acknowledges. Each suffers risks, in fact.

Regarding (1): Finding that the conversion failed the safe harbor requires a highly technical reading and in any event merely establishes a failing of a safe harbor, not taxability. Regarding (2): The section 707(a)(2)(A) argument requires applying regulations that don't exist. Regarding (3): The 707(c) argument might fail because only 707(a)(2)(A) was intended to apply to transactions of this type.

Polsky offers compelling arguments that potentially overcome these significant hurdles. But I'm left with the distinct impression that a court really could go either way and that (as Polsky acknowledges) the precise contractual arrangements in any given case will influence the outcome.

I can think of many profoundly piggish tax shelters, but this is a long cry from one. For me, the drama is missing from the substantive tax issue, although I understand why it's an irresistible topic. ("Masters of the Universe" potentially cheating on their taxes?! Oh my!).

[Bernie Burk]

Andy, Your comments are a useful substantive counterpoint in this discussion, so thanks for offering them. With respect to the constructive receipt issue, you are probably right that the terms and circumstances of the "waiver" will affect the strength of that argument. My understanding is that, in many if not most of the funds in which this practice is indulged, there is little real risk because of timing, economics or both.

With respect to how arguable the other substantive tax issues are, the fact that there will be skilled and knowledgeable tax practitioners gladly accepting close to $1,000 per hour to argue that this is really OK should not reduce this to a "we just report the controversy" situation. The abusive tax shelters of the 00s --for which people went to jail--were ably defended by some of the finest tax lawyers and litigators on the planet (and I want to be clear that I consider it completely appropriate for them to have done so). That didn't make the shelters defensible.

The fact that many academics tend to gentle statements of their views should not be confused with whether those views are soft. Several tax scholars of national stature in addition to Polsky have condemned this practice. E.g, Victor Fleischer (Colorado) http://dealbook.nytimes.com/2012/09/04/whats-at-issue-in-the-private-equity-tax-inquiry/ (“legally questionable and might not hold up in court”); Ed Kleinbard (USC; former Joint Committee on Taxation Chief of Staff; former Cleary partner) http://online.wsj.com/article/SB10000872396390443571904577629831800831466.html (“firms ended up taking positions that I think went beyond what the law permitted”); Dan Shaviro (NYU) http://danshaviro.blogspot.com/2012/08/has-romney-paid-all-us-federal-income.html (“many reputable tax lawyers” believe fee waivers are “bogus” and “could not withstand legal challenge”).

Here in North Carolina, the hog-raising capital of the world, we know a pig when we see one. I stand by my comments.

--Bernie

[andy]

Bernie,

Thank you for your response, although I'm compelled to point out that here in Iowa, we know something about pork too ;).