Home   |  Contact Us   |  Directions   |  Site Map

 www.MRobinson.com
The Landmark Building
160 Federal Street, 6th Floor
Boston, MA 02110
Phone: 617-428-6900
Fax: 617-428-0090

New Insights on Mitt Romney’s Tax Returns:
Why Romney’s Effective 2010 Income Tax Rate is only 10.7 Percent

 

M. Robinson & Company, P.C.
160 Federal Street, 6th Floor
Boston, MA 02110
617-428-6900
www.MRobinson.com
January 31, 2012
By Attorney Morris N. Robinson, CPA, LLM*


BOSTON. Over the past few days, I have reviewed the 2010 income tax returns of Mitt and Ann Romney and of various Romney family trusts including their private charitable foundation. I found that, contrary to published reports, the effective United States income tax rate1 on Mitt’s and Ann’s total effective 2010 income of $28 million was only 10.7 percent– and NOT 13.9 percent as reported by the press.2

These returns reveal the tax-savings techniques used by Mitt and Ann to reduce their income, gift and estate taxes. All techniques are completely legal. Many of these techniques are prosaic and are available to all Americans. These techniques acquire their impressive tax-saving power through thoughtful coordination by highly-competent tax attorneys and tax accountants.

Legal Techniques Used by Mitt and Ann to Reduce Their 2010 Income Taxes

The most important tax-reduction techniques used by Mitt and Ann to reduce their 2010 income taxes are listed below.
  • “Carried Interest.” Mitt and Ann Romney earned about $9 million in “carried interest”3 from various partnerships sponsored by Bain Capital. “Carried interest” represents deferred compensation to Mitt Romney for managing a number of Bain Capital partnerships.4 Unlike other compensation which is subject, without any ceiling, to both the Medicare tax and to high income tax rates, “carried interest” is typically taxed only at long-term capital gains rates. The maximum tax rate on “carried interest” is 15 percent for both the regular income tax and the alternative minimum tax. Thus, the 2010 tax savings to Mitt and Ann from treating Mitt’s 2010 deferred compensation as “carried interest” is approximately $2 million, as follows (in millions):

                                                             Income Tax Savings (20 percent5 of $9 million6 )         $1.8

                                                             Medicare Tax Savings (2.90 percent7 of $9 million)        0.2

                                                             Total Tax Savings                                                                  $2.0

  • Long-Term Passive Investment Capital Gains. Mitt and Ann Romney enjoyed long-term capital gains from investments of $7.9 million.8 This income is also subject to a maximum tax rate of 15 percent for both the regular income tax and the alternative minimum tax.
     
  • Long-Term Capital Loss Carryforward. Mitt and Ann Romney had a long-term capital loss carryforward of $4.8 million from years prior to 2010. This long-term capital loss carryforward offsets both the 2010 “carried interest” and the 2010 long-term capital gains from investments, both of which are described above. This loss-carryforward deduction must be added back to Mitt’s and Ann’s reported 2010 income to arrive at their total 2010 income.
     
  • Qualified Dividends. Dividends from corporations organized in the United States (qualified dividends) are taxed at only 15 percent. Mitt and Ann reported about $3.3 million of qualified dividends subject to the 15 percent tax rate.
     
  • Charitable Deductions Offset Higher-Taxed Income. Mitt and Ann had about $3.3 million in interest income and $1.6 million in nonqualified dividends; presumably, these dividends are from companies organized outside the United States. This interest and non-qualified dividend income was subject to the higher 28 percent alternative minimum tax rate and NOT to the lower 15 percent long-term capital gains rate. Much of this higher-taxed income was offset, however, by charitable contributions of $3 million, thereby reducing the amount of Mitt’s and Ann’s income subject to the maximum 28 percent alternative minimum tax rate to only $2.6 million.9
     
  • Donation of Appreciated Low-Basis Stock to Private Charitable Foundation. Mitt and Ann donated about $1.5 million of what I believe to be appreciated low-basis stock (mostly stock in Domino’s Pizza Inc.) to their private charitable foundation (The Tyler Charitable Foundation). This donation provided Mitt and Ann with five interrelated tax benefits:


    1. Legally Excluded 2010 Capital Gains. Mitt and Ann legally excluded from their 2010 capital gains income the appreciation in the value of their donated stock.  This legally excluded capital gain must be added back to Mitt’s and Ann’s 2010 reported income to arrive at their total 2010 income. I note that this exclusion saved Mitt and Ann as much as $225,000 in income taxes, assuming that the donated stock was worth $1.5 million and had close to a zero tax basis (tax cost). I used the 15 percent long-term capital gains rate to compute the tax savings on $1.5 million of gain since that is the long-term capital gains rate for both the regular tax and the alternative minimum tax.
       
    2. Deductions in Excess of Tax Basis. Mitt and Ann deducted the full value of the stock – even though it is likely that their tax basis in the stock was far LESS than the value of the stock at the time they donated it to their private charitable foundation.
       
    3. Donation Offsets Highly Taxed Income/Computation of Tax Benefit. The $1.5 million charitable donation offsets income that otherwise would been taxed at the 28 percent maximum alternative minimum tax rate. The tax savings associated with the charitable contribution deduction is approximately $420,000, or 28 percent of $1.5 million. This tax savings is in addition to the approximately $225,000 in tax savings arising from legally excluding the $1.5 million gain from income.  Thus, the total tax savings is $645,000, as follows:

                               Exclusion of Gain on Disposition of Stock    $225,000

                               Charitable Contribution Deduction                   420,000

                               Total Estimated Tax Savings                           $645,000
       
    4. Delayed Contribution to Final Recipients. Mitt’s and Ann’s private charitable foundation contributed $648,500 to various charities, including $145,000 to the Church of Jesus Christ, Latter Day Saints.11 The foundation held the balance of the $1.5 cash contribution – over $800,000 – at the end of calendar year 2010. Thus, although Mitt and Ann received a charitable contribution deduction of $1.5 million, less than half of that money was contributed to final recipients by the end of calendar year 2010. In contrast, Americans who cannot afford to set up private foundations must complete their contributions to final recipients by the end of the calendar year to take their charitable contribution deductions.
       
    5. Contributions to Final Recipients Equals Approximate Tax Savings. I note that the $648,500 in total grants made by Mitt’s private charitable foundation in 2010 approximately equals the estimated tax savings of $645,000.12
       
  • Foreign Tax Credit. About 8 percent (about $1.5 million) of Mitt’s and Ann’s income came from sources outside the United States. To avoid double taxation, Mitt and Ann received dollar-for-dollar reductions in their United States tax liability for income taxes paid to foreign countries. In 2010, Mitt and Ann used the foreign tax credit to reduce their income taxes on foreign income by $129,000. They did this (1) by paying $67,000 in income taxes to foreign countries in 2010 and (2) by utilizing $62,000 of unused foreign tax credit carryforwards from prior years.



Other Important Tax-Saving Techniques

Mitt and Ann used two other important tax-savings techniques: an “intentionally defective” grantor trust and a private charitable foundation.
  • “Intentionally Defective” Grantor Trust. According to published reports,13 Mitt and Ann set up a trust for the benefit of their five children in 1995 and funded it with just over $2 million in assets. Today, this trust is worth about $100 million. The assets in this trust are treated as a completed gift both under trust law and for United States gift tax and estate tax purposes. These assets, however, are treated as belonging to Mitt and Ann for United States income tax purposes. This dissonance in the law provides Mitt and Ann with three powerful methods for reducing their gift and estate taxes.
  1. Entire Original Gift Escapes Gift Taxation. The original gift of just over $2 million likely escapes United States gift taxation. In 1995 the lifetime combined gift tax exemptions for a married couple totaled $2 million. Since Mitt and Ann presumably used their lifetime exemptions in 1995, they did NOT have to pay any gift taxes on the original $2 million transfer.
     
  2. Entire Appreciation of Trust Assets Escapes Estate Taxation. The appreciation in the value of the trust assets since 1995 – as much as $100 million – escapes estate taxes since Mitt and Ann made completed gifts in 1995. Once a completed gift is made, the appreciation is excluded from the estate of the donor for United States estate tax purposes.
     
  3. Special Tax-Free Gift of Roughly $1.5 Million. The roughly $100 million in trust assets generates significant income. Under trust law the trust income belongs to the trust and its beneficiaries. Under income tax law, however, the income from this “intentionally defective” trust “belongs” to Mitt and Ann. Thus, Mitt and Ann must report the trust income as their own and are legally required to pay the roughly $1.5 million in income taxes on their children’s trust income. In contrast, the trust and the five Romney children do not have to pay any portion of the income taxes arising from their trust income.

    This dissonance between trust law and the tax law resulted in additional “gifts” to the five Romney children of roughly $1.5 million – or $300,000 per child – representing the amount of income taxes that Mitt and Ann paid on their children’s trust income. These “gifts” of income tax payments are not subject to either gift taxes (for Mitt and Ann) or income taxes (for Mitt’s and Ann’s five children.) Moreover, these “gifts” effectively reduce Mitt’s and Ann’s gross estates, thereby reducing their own estate taxes. Finally, the overall income tax liability is less. By paying the taxes, Mitt and Ann are able to offset their charitable contributions against trust income thereby reducing the Romney family’s overall income tax burden as discussed above.
  • Private Charitable Foundation. Mitt and Ann’s private charitable foundation allowed them to sell appreciated low-basis stock in Domino’s Pizza without capital gains tax. First, they donated some of their Domino’s Pizza stock to their foundation. Then, their foundation sold the stock. The foundation, being a section 501(c)(3) organization, was not subject to tax. Thus, the entire gain on the sale – as much as $1.5 million – escaped income taxation.
     



Computation of Effective 2010 Income Tax Rate and Related Reconciliations


Effective 2010 Income Tax Rate

Mitt and Ann had a 2010 tax of $3 million on total 2010 income of $28 million, resulting in an effective tax rate of 10.7 percent. ($3 million/$28 million). If Mitt and Ann’s so-called carried interest19 were taxed at the 35 percent highest regular tax rate, their total taxes would increase to $4.8 million  and their effective tax rate rises to 17.2 percent  ($4.8 million/$28 million). The reconciliations of 2010 taxes, 2010 total income, and 2010 total capital gains income follow immediately below.

2010 Total Tax Reconciliation

Mitt and Ann paid just over $3 million in total taxes on their 2010 total income, as follows:

Regular Income Tax (Form 1040, Page 2, Line 44)                   $2,873,054

Alternative Minimum Tax (Form 1040, Page 2, Line 45)                 232,989

Foreign Tax Credit (Form 1040, Page 2, Line 47)                         (129,697)

Miscellaneous Credit                                                                                       (1)

Self-Employment Tax (Form 1040, Page 2, Line 56)                         29,151

“Nanny Tax” (Form 1040, Page 2, Line 59)                                            4,270

Total Taxes Paid (Form 1040, Page 2, Line 60)                              $3,009,7


2010 Total Income Reconciliation

Mitt’s and Ann’s total 2010 income of $28 million reconciles to the income they reported on Page 1, Line 22 of their Form 1040 for 2010, as follows (in millions):

Income Reported on Mitt’s and Ann’s United States Income Tax Return
(Form 1040, Page 1, Line 22)                                                                                          $21.7

Add Back: Long-Term Capital Loss Carryforward from
Prior Years Legally Deducted From 2010 Capital Gains Income                                 4.8
    
Add Back: Gain on the Contribution of Appreciated Low-Basis
Shares to Mitt’s and Ann’s Private Charitable Foundation
Legally Excluded From 2010 Capital Gains Income14                                                   1.5

Total 2010 Income                                                                                                             $28.0
 
2010 Total Long-Term Capital Gains Income Reconciliation

Mitt’s and Ann’s total 2010 long-term capital gain income reconciles to the long-term capital gains income they reported on Form 1040, Schedule D, Line 15 as follows (in millions):

Carried Interest – Mitt’s and Ann’s Family Trust15                                               $4.5

Carried Interest – Ann’s Blind Trust16                                                                        4.5

Investment Long-Term Capital Gains17                                                                   7.9
Capital Losses Carried Forward from Prior Years and Deducted
From 2010 Capital Gains Income (Schedule D, Line 14)                                 (4.8)

Long Term Capital Gains Reported on Form 1040,
Schedule D, Line 15                                                                                                $12.1

Add Back: Long-Term Capital Loss Carryforwards from
Prior Years Legally Deducted From 2010 Capital Gains Income                       4.8
    
Add Back: Gain on the Contribution of Appreciated Low-Basis
Shares to Mitt’s and Ann’s Private Charitable Foundation
Legally Excluded From 2010 Capital Gains Income                                             1.5

Total 2010 Capital Gains Income                                                                         $18.4

  1. As used in this article, the term “effective tax rate” refers to the percentage that results from dividing total tax liability by current year (2010) income. When calculating current year income for 2010, I do not subtract capital losses carried forward from prior tax years against capital gains realized in 2010. Because such a significant percentage of the Romneys’ income is generated from long-term capital gains, I feel that it is more appropriate to calculate the Romneys’ effective rate of tax in 2010 by focusing on the capital gains realized in 2010 only without reference to capital losses carried forward from prior tax years. For details regarding our computation of the 10.7 percent effective tax rate, please see the section of this article entitled Computation of Effective 2010 Income Tax Rate and Related Reconciliations, below.
     
  2. See, e.g., Nicholas Confessore and David Kocieniewski, For Romneys, Friendly Code Reduces Taxes, N.Y. TIMES, Jan. 24, 2012, available at http://www.nytimes.com/2012/01/25/us/politics/romneys-tax-returns-show-21-6-million-income-in-10.html?_r=1&scp=1&sq=romney%20income%20tax%20returns&st=cse (last visited January 26, 2012).
     
  3. For a detailed explanation of the term “carried interest,” including analysis of United States income taxation of carried interest and related policy questions, see Statement of Peter R. Orszag, Director, Congressional Budget Office, before the Committee on Ways and Means, U.S. House of Representatives (Sept. 6, 2007), available at http://www.cbo.gov/ftpdocs/85xx/doc8599/09-06-CarriedInterest_Testimony.pdf (last visited January 26, 2012).
     
  4. “Carried interest” is NOT required to be separately reported on Mitt’s and Ann’s 2010 income tax returns. I estimated the $9 million of “carried interest” by treating all long-term capital gains from Bain Capital partnerships as “carried interest.” I treated long-term capital gains from all other partnerships—such as Goldman Sachs investment partnerships—as long-term capital gains arising from passive investments. These other long-term capital gains amounted to $7.9 million. See section of this article entitled Computation of Effective 2010 Income Tax Rate and Related Reconciliations, below.
     
  5. The income tax rate differential of 20 percent is the difference between the highest individual income tax rate of 35 percent and the long-term capital gains rate of 15 percent for both regular and alternative minimum tax purposes.
     
  6. See note 4, above.
     
  7. The Medicare tax of 2.9 percent is allocated equally to the employer (1.45 percent) and the employee (1.45 percent). If Mitt is not an employee of his partnership, his share of the Medicare tax would be the entire 2.9 percent.
     
  8. See note 4, above.
     
  9. Mitt and Ann contributed approximately half of their $3 million charitable contributions (about $1.5 million) in cash directly to the Church of Jesus Christ, Latter Day Saints. They contributed the remaining half (about $1.5 million) in appreciated low-basis stock (mostly in Domino’s Pizza Inc.) to their private charitable foundation. For details, see section of this article entitled Donation of Appreciated Low-Basis Stock to Charitable Foundation, immediately below.
     
  10. This estimated tax savings of $225,000 assumes that the appreciated stock had a zero basis. Of course, if the cost basis of the stock is greater than zero, then the estimated tax savings would be less than $225,000.
     
  11. The complete listing of the recipients of the $648,500 in 2010 grants is reflected on Attachment 13 to Mitt’s and Ann’s Private Foundation Form 990-PF for 2010.
     
  12. See items #3 and 4, immediately above.
     
  13. Floyd Norris, Romney Paid More Than He Owed, N.Y. TIMES, Jan. 27, 2012, available at http://www.nytimes.com/2012/01/27/business/economy/mitt-romney-paid-more-taxes-than-he-owed-high-low-finance.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+Counterparties+%28Counterparties%29 Last visited January 27, 2012.
     
  14. I add back $1.5 million in gain on the contribution of appreciated shares with the assumption that (1) the shares had a zero basis and (2) the Romneys avoided recognizing capital gain income in 2010 by donating the shares to their charitable foundation instead of selling the shares at fair market value.
     
  15. For my discussion of carried interest, see notes 3 and 4, above, and accompanying text.
     
  16. Id.
     
  17. See note 6, above, and accompanying text.
     
Copyright © 2014 Law Offices of M. Robinson & Company, P.C. All rights reserved.
Powered by DreamingCode.