Why Romney's tax returns matter

New York TimesAugust 1, 2012 

Pressure is mounting for Mitt Romney to release more of his financial records. Romney has made public only his 2010 tax returns and has said his 2011 documents will be released soon. “That’s all that’s necessary for people to understand something about my finances,” he said recently. He is “simply not enthusiastic,” he also said, about giving the Obama campaign “hundreds or thousands of more pages to pick through, distort and lie about.”

But it is a good bet that Romney’s vetters have picked through more than two years of returns of his vice presidential contenders. And the Senate typically requires more for confirmation to a Cabinet or even a subcabinet post. Until Romney recognizes the right of voters to understand the finances of their leaders, all we are left with is speculation.

Some commentators have suggested, for example, that – like tens of thousands of other Americans who have taken advantage of an Internal Revenue Service amnesty – he might not have declared and paid taxes on his Swiss bank account. I can’t imagine that he would have engaged in such blatant tax cheating. He is far too smart for that.

Another suggestion is that in 2009 he paid income taxes significantly below the 13.9 percent he paid in 2010. This is more plausible, and potentially more damaging politically, even if perfectly legal.

After all, the one year’s tax returns that he has released raise doubt about his campaign’s claims that his offshore accounts did not save him one penny of tax. Putting business assets into an individual retirement account invested in a Cayman Islands corporation allows Romney to avoid the “unrelated business income tax” – a 35 percent levy – on at least some of his IRA’s earnings, a tax that he would have had to pay if his IRA were held directly by a financial institution in the United States.

With an IRA. account of $20 million to $101 million, the tax savings would be more than a few pennies.

The IRA. also allows Romney to diversify his large holdings tax-free, avoiding the 15 percent tax on capital gains that would otherwise apply. His financial disclosure further reveals that his IRA. freed him from paying currently the 35 percent income tax on hundreds of thousands of dollars of interest income each year.

Given the extraordinary size of his IRA, we have to presume that Romney valued the assets he put in his retirement account at far less than he would have sold them for. Otherwise it is quite a trick to turn contributions that are limited to $30,000 to $50,000 a year into the $20 million to $101 million he now has there. But we cannot be certain; his meager disclosure of tax records and financial information does not indicate what kind of assets were put into the IRA.

Romney’s Cayman Islands and Bermuda corporations also probably allowed him to avoid limitations on deductions for investment expenditures that would otherwise apply. So we don’t need any more tax returns to know that Romney is an Olympic-level athlete at the tax avoidance game. Rich people don’t send their money to Bermuda or the Cayman Islands for the weather.

Moreover, we have no clue whether Romney paid any gift tax on transfers, now valued at $100 million, to a trust he set up in 1995 for the benefit of his five sons. Until this year, the federal gift tax had a lifetime exemption of $1 million, and it taxed gifts in excess of that amount at rates between 29 and 44 percent. A gift of $100 million to one’s children could, therefore, require paying a tax of as much as $29 million to $44 million.

But every good tax professional knows that gift tax returns are rarely audited, except after the transferor’s death. And normally the I.R.S. cannot challenge such a return after three years from its filing. But if the values of the gifts were not properly appraised and disclosed on Romney’s gift tax returns, a challenge may still be possible. If he did not file any gift tax return, he would still be liable for the tax, plus interest and penalties.

Based on his aggressive tax planning, revealed in the 2010 returns he has released and his approval of a notably dicey tax avoidance strategy in 1994 when he headed the audit committee of the board of Marriott International, my bet is that — if Romney filed a gift tax return for these transfers at all — he put a low or even zero value on the gifts, certainly a small fraction of the price at which he would have sold the transferred assets to an unrelated party.

Otherwise, he should be happy to release his gift tax returns. According to a partner at Romney’s trustee’s law firm, valuing carried interests, such as Romney’s interests in the private equity company Bain Capital, at zero for gift tax purposes was common advice given to clients like Romney in the 1990s and early 2000s.

If detected, undervaluing large gifts to one’s children could provoke large penalties from the IRS. These are the kinds of tax penalties that even multinational corporations try to avoid because they fear how the public would react to the adverse publicity that would inevitably follow.

To settle these questions, Romney should release his gift tax returns, or other documents showing how he valued his transfers to his family’s trust and to his IRA, and at least three additional years of income tax returns.

No one should begrudge Romney or his family the wealth they have earned. But if he has not paid the taxes that apply to transfers of such wealth, this should concern us all. After all, who do you think pays for the shortfall?

The New York Times

Michael J. Graetz, a professor of tax law at Columbia University, was the deputy assistant Treasury secretary for tax policy from 1990 to 1991, and an assistant to the Treasury secretary in 1992, under the first President Bush.

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