In a comment to my post yesterday titled “Romney’s VERY Private Equity,” which asked how Romney was able to metasticze his Bain-era IRA account to accumulate more than $100 million—Investment in Apple stock? In precious-metals funds? A quiet Louvre heist? I asked—reader Steve Hamlin wrote:
Beverly,
Re: Romney’s IRA contributions, there was a WSJ article in the past several days that talked about them – they were often a special share class of the PE deals that Bain invested in, where the majority of the value of the company was assigned to the other share class. There are examples of these “low-value class” shares making 600% in several years.
The tax strategy (made sense at the time, less so now) was to put these high(?)-risk, high-reward share classes in your IRA, and your mandatory allocation of the other (lower risk, lower reward) share class in to your taxable brokerage account.
The article quotes tax professionals who question the aggressiveness of the Bain share class valuations.
Source: http://professional.wsj.com/article/SB10001424052970204062704577223682180407266.html?mg=reno-wsj
I wrote up a reply to Steve’s comment, but the Comments function won’t let me post it there because the comment is too long. So, here it is:
Thanks, Steve. When I read your comment, I remembered reading something about this in the Vanity Fair article (which I read only once, on Jul. 3), and just went back and reread that part of it. Here’s what it says:
The Romneys won’t say, but Mark Maremont, writing in The Wall Street Journal, uncovered a likely explanation. When Bain Capital bought companies, it would create two classes of shares, named A and L. The A shares were risky common shares, to which they would assign a very low value. The L shares were preferred shares, paying a high dividend but with the payoff frozen, and most of the value was assigned to them. Bain employees would then put the exciting A shares in their I.R.A. accounts, where they grew tax-free. With all the risk of the deal, the A shares stood to gain a lot or collapse. But if the deal succeeded, the springing value could be stunning: Bain employees saw their A shares from one particularly fruitful deal grow 583-fold, 16 times faster than the underlying stock.
The Romneys won’t tell us how, or even if, they assigned super-low values to the A shares, but there are a couple of ways to do it. One is to use standard options models to price the shares—then feed inappropriate assumptions into those models. Romney could alternatively have used a model called liquidation valuation, which Kleinbard [Ed Kleinbard, a USC tax law professor whom the author contacted in researching the issue] says would have been “completely inappropriate.” Without seeing the assumptions used on Romney’s tax returns from the years when those lowball A shares were squirted into his I.R.A., we cannot know how he did it. Whatever methods he used, however, the valuations were, according to Andrew Smith, of Houlihan Capital in Chicago, “pushing the envelope.” (Andrea Saul retorts, “Why should successful investments be criticized?”)
I remembered that when I read those paragraphs last week, I said to myself in answer to Saul’s rhetorical question: “The relevant question here is not whether successful investments should be criticized, but instead whether illegalinvestments should be criticized.” The investments themselves weren’t illegal, but the classification of the stock into two arbitrarily-divided classifications in order to give falsely low valuations on one class in order to create huge nontaxable profits, sure as hell sounds to me like it wasillegal.
Krugman says there possible legal ways that the IRA gains could have been so huge. But the way described in the Vanity Fair article and in the WSJ article doesn’t appear to be legal in Romney’s instance, even though this tactic would be legal in other instances—i.e., when there is some actual tangible difference between the risk and value of the two classes of stocks, and when the stock placed in the IRA is given a legitimate, rather than fraudulently low, value.
The relevant paragraphs of the WSJ article read:
The tax-deferral opportunity stemmed from the way Bain often chose to structure the shares of companies after taking them over.
Even if the companies had only one share class, Bain frequently gave them two classes, usually called Class L and Class A, according to former employees, Bain internal documents and securities filings. Because Bain controlled the companies, it had flexibility in assigning values to the classes.
Class L shares, akin to preferred stock, were safer and had a higher initial value. They had priority if the company paid dividends, and holders of these shares were the first to receive proceeds from a sale or liquidation. The shares also accrued interest, often at 10% to 12%.
Bain assigned a much lower value to Class A shares, which were riskier but potentially more profitable.
If Bain sold or liquidated a company it had taken over for less than was owed to Class L shareholders, the Class A shares lost all of their value.
But once Class L shareholders got their money, Class A shareholders received the bulk of additional gains, often as much as 90% of them, according to the documents and former employees. In successful deals, the A shares could skyrocket.
Can it really be that all that was legally necessary was to simply separate objectively identically-valuable stocks from a single company into two classes of stocks whose only difference is the arbitrary value that the company assigns the stocks, rather than the actual tangible value of the stocks?
—-
Cool! Thanks, Mr. Blodget!
Then this afternoon, he posted a follow-up titled “
Wait—MaybeTHIS Is How Mitt Romney Got So Rich…,” in he explains (based on the surprising revelation in the Boston Globe article that during the period of 1999 to 2002Romney owned 100% of Bain stock), how Romney’s IRA account might actually have acquired so much money legally.
Since Blodget may well have figured out how that IRA came to be worth so much, without even having to channel Sherlock Holmes, I thought I should let readers know. Although I think he may be wrong and that Bain really did stage a quiet Louvre heist. Has anyone noticed whether Mona Lisa looks slightly more like a Bain CEO than she used to?
You might want to check out IRS law 6707a…..you can’t self deal in your own IRA. I know. I sold shares to my Roth IRA and the IRS came after me. Check it out.
Thanks, Anonymous. I emailed the Obama campaign a link to my post and received back an email saying that they agree with me that this is something that they should look into. I’m pretty clueless about tax law—I joke that I’ll first have to learn to add and subtract before I attempt to understand tax law—so I thought I might be missing something obvious on this. But, really, I’ll be pretty surprised if it turns out that it was legal to do what Romney did.
When is a loophole a fraud? As much as I believe this amounts to a complete scam by Mitty Mitt I will get my own cynicism challenged if the IRS bothers to do anything about it.
But either way it surely explains much about why the candidate is so reluctant to reveal much about his personal tax returns. This looks like a pure scam.
i’ve followed these romney threads as little as possible so i dont know if someone has already caught this:
http://news.firedoglake.com/2012/07/12/romney-discrepancies-over-when-he-left-bain-capital-could-constitute-a-felony/
(lied on a SEC filing)
‘Course all of this is speculation; he really should release all of the information. Of course, if he doesn’t, I suppose speculation, no matter how irresponsible, is to be expected and fair under the circumstances.
Very interesting point above about self dealing. We have the same thing in the UK with our pension SIPPs.
wont the withdrawsls be taxed at 35 percent? If so, he made a bad business decision.
This comment has been removed by the author.
Presumably, they’re capital gains. And if his kids inherit it, as they probably will–it’ll be taxed at the estate-tax rate, which, if he becomes president, will be 0%.
You can contribute after-tax amounts to an IRA too. Doesn’t have to all be pre-tax.
If his kids get it, they’ll get a stepped up basis but also mandatory withdrawals during their lifetimes. So the IRA scam (no other possible word) gets big tax deferral but not avoidance. A Roth IRA would have been better because no mandatory withdrawals, but they were not available at the time.
Under a traditional IRA you can contribute after tax $$ if you exceed AGI limits; Mitt surely exceeded those, and so his contributions were probably after tax, but since it was to a traditional IRA all it gets is tax deferral. It is only in the more recent Roth IRA that you can contribute after-tax $$ and get non-taxable gains on those contributions in the IRA.