Last night, courtesy of a media organization that got some materials in advance, I was able to spend a short time looking at some of the information from Governor Romney's 2010 tax return, along with some tentative and preliminary 2011 items. As I will be colloquiumizing, so to speak, while this story is bright and fresh today, I am writing up my main preliminary reactions in advance and will post them when the story has gone public.
1) Roughly speaking, Romney shows annual adjusted gross income (AGI) in the range of just over $20 million per year, and is paying income tax on this at a rate of about 15% or perhaps a mite below. This is as expected, and raises a set of issues not about his compliance or tax planning activity, but about the merits of the underlying rules that yield this result. A key reason for the low average tax rate (computed relative to AGI) is that about half of his income comes from long-term capital gains that are presumably mainly or wholly Bain carried interest payouts. Taxing these as capital gains rather than ordinary income may have saved him about $2 million a year, all else equal. He also lowered his average tax rate through significant charitable contributions, in particular to his church and with a higher amount in 2011 than 2010. Obviously he can argue that paying less tax due to charitable contributions is different than doing so by reason of tax planning or favorable tax rules for what is classified as capital income.
2) He appears to have had the full measure of disallowed miscellaneous itemized deductions under the "2% of adjusted gross income" floor, and thus apparently did not use Caymans entities to avoid this problem, as David Miller's NYU Tax Policy Colloquium from last year suggested may be common practice in some circles.
3) Not to bury the lede, but the single most interesting thing I saw is that he had a $4.8 million capital loss carryover in 2010. In other words, for 2009, his capital losses exceeded his capital gains (including from the Bain carried interests) by $4.8 million. So he had zero net capital gains, and zero tax on his carried interest income, in 2009. I had speculated in an earlier post that the fact that the carried interest gives rise to capital gain might benefit him not only by lowering the tax rate on the income from 35% to 15%, but also by permitting it to be offset by capital losses, and now we see this confirmed.
The really interesting question is: What was the reason for these sizable capital losses? An obvious possibility that comes to mind is that 2009 was not exactly the greatest year ever in the history of the stock market. But it would be interesting to know more about this. It would also be interesting to know more about whether he had capital losses offsetting his capital gains in 2008, which of course is when the current financial crisis broke out, and for that matter in 2007 and earlier.
On the Democrats' (or even Gingrich?) side, I would be tempted to make a lot of this: "He didn't pay ANY tax on his Bain carried interest income in 2009 and perhaps earlier!" But of course our income tax employs a net rather than a gross concept of income. If you make $10 million here but lose $10 million there, your net is zero and you are supposed to pay tax of zero.
But - taxpayers can be quite artful about the losses that appear on their returns. Thus, suppose you have a stock portfolio with both huge gains on some stocks and huge losses on others - reflecting diversification and perhaps a willingness to take a wide array of risks. Then you sell the losers and hold the winners, and you get huge loss deductions (offsetting the carried interest income) that misrepresent the actual economic performance of your portfolio as a whole. This would involve entirely legitimate tax planning, which I might do as well if in Romney's tax position, but then it would indeed mean that he was paying zero tax on his carried interest income despite not actually having net losses from his portfolio holdings.
Another possibility is that one can create fake capital losses (or at least take a reporting position that one has done so) through aggressive tax planning tricks that, for example, create fake basis in assets to permit the deduction of fake losses. There is no evidence whatsoever that Romney did this, but the possibility underscores the point that one might really like to know more about the source and reality of the capital losses that Romney claimed or perhaps harvested in 2009.
If I were on the other side of this politically, I would use the 2010 capital loss carryover as grounds supporting the demand to see earlier years' tax returns, as well as perhaps non-tax return information that might shed light on what was really going on here economically. Again, it may just be a matter of having an exceptional year in which the recession and stock market collapse gave him large losses that he realized, but one can't tell for sure from the information that has thus far been released.
4) Romney has lots of PFIC investments on which he reports, and on which he takes the QEF election - but there's something baffling to me about what's reported. Oops, a lot of jargon in that last sentence. Let's explain. In general, passive foreign investment companies (PFICs) are foreign corporations in which one owns shares, and which are primarily engaged in passive portfolio investment rather than actively running controlled businesses. To prevent U.S. individuals from incorporating their stock portfolios abroad and avoiding current tax, the PFIC rules require current year taxable income inclusion of one's share of the income thus generated, or its deferred (but with interest) equivalent. The QEF election means that you elect to be taxable currently, since the deferred alternative is generally worse. Romney has lots of PFICs - some Bain, some Goldman Sachs, and others as well - that are incorporated all over the place: the Caymans, Ireland, Luxembourg, Switzerland, Germany, I believe the U.K., etcetera. But the odd thing about it is that the PFIC income he reports for 2010 tends to be really trivial amounts, like $2,000 here and $800 there. (I.e., not just trivial in his specialized sense, a la the $370,000 in speech fees that he mentioned.) What I don't understand is why this is. Were the PFICs doing poorly in the 2010 economic environment? Is most of his real money in tax-deferred IRAs, so we are only seeing a tiny piece in the taxable realm? Is there tax planning going on off-screen, at the PFIC level, such that he might have more economic income than taxable income from all these PFICs? Someone who knows more about practice in this area might have a better sense of it than I do.
5) For 2010, Romney filed several Form 8886, Reportable Transaction Disclosures with the IRS. These were generally for investments through a Goldman Sachs hedge fund. I couldn't see what the transactions were, since the forms stated that a full textual explanation was being provided on separate pages that were not available, at least in what I saw.
Reportable transaction disclosures generally pertain to transactions that the IRS and Treasury find suspicious as potentially improper tax shelters. They typically have a high ratio of tax benefits to cash invested and/or economic substance, and the government thus wants a chance to look them over more carefully. Or they may have triggered the disclosure requirement in other ways, such as by reason of being offered confidentially. The fact that you have reportable transactions doesn't by itself support any definite conclusions. For example, the IRS may end up agreeing that all of these transactions were reported properly and had the tax consequences that were claimed. Or it may disagree but lose in court. Or it may disagree and win in court, but you believed in good faith that your positions were valid.
So no definite conclusions of any kind can be drawn from Romney's having reportable transaction disclosures - especially since I don't even know what these transactions were or what tax benefits they may have produced. Nonetheless, the fact that his return includes these things is of interest, and raises the question of whether he was engaged (mainly through Goldman, it seems) in aggressive tax planning.