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Management Fee Conversion

Posted by david52 z5CO (My Page) on
Tue, Aug 28, 12 at 18:44

snip - begin quote "Current law on carried interest is already a sweetheart tax deal for private equity, but why not make it better? Private equity folks are not the type to walk past a twenty-dollar bill lying on the sidewalk. In the 2000s it became common for private equity fund managers to "convert" their management fees into carried interest. There are many variations on the theme, but here's how many deals worked: each year, before the annual management fee comes due, the fund manager waives the management fee in exchange for a priority allocation of future profits. There is minimal economic risk involved; as long as the fund, at some point, has a profitable quarter, the managers get paid. (If the managers don't foresee any future profits, they won't waive the fees, and they will take cash instead.) In exchange for a minimal amount of economic risk, the tax benefit is enormous: the compensation is transformed from ordinary income (taxed at 35%) into capital gain (taxed at 15%). Because the management fees for a large private equity fund can be ten or twenty million per year, the tax dodge can literally save millions in taxes every year.

The problem is that it is not legal. Because the deals vary in their aggressiveness, there is some disagreement among practitioners about when it works and when it doesn't. But in my opinion, and the opinion of many tax practitioners, the practices that were common in the private equity industry in the 2000s became very, very questionable, and it's unlikely that they would have stood up in court.

Fund VII. Gawker today posted some Bain documents today showing that Bain, like many other PE firms, had engaged in this practice of converting management fees into capital gain. Unlike carried interest, which is unseemly but perfectly legal, Bain's management fee conversions are not legal. If challenged in court, Bain would lose. The Bain partners, in my opinion, misreported their income if they reported these converted fees as capital gain instead of ordinary income.

Here's one example, from Bain Capital Fund VII LP (2009), pp. 13-14 (see here). In any given year, the manager (Bain) can waive its management fees, and allocate the fees instead to a particular investment in the fund. If that investment appreciates in the future, the general partner (Bain) takes a "Priority Profit" off the top. While Bain did not waive its fees for this fund in 2009, it had done so earlier in the life of the fund, to the tune of tens of millions of dollars. (5% of its total holdings of Bombardier Recreational, for example, came from fee conversions - making the fee conversions alone worth about $7 million in 2009).

To be clear, there is some economic risk, and presumably this is how Bain's tax counsel justified its reporting. The economic risk is that the priority profit must come from future profits, presumably from the investment to which the converted fee is allocated. On the other hand, the managers get to choose which investment in the portfolio they want to skim, and they are in a good position to know which investments are safest. Because the fees come off the top, they are not subject to real investment risk, but only the limited risk that even their best investments will decline in value, every single quarter, for the rest of the life of the fund. Even in 2009, an iffy year for Fund VII, the priority profit share increased in value by $3.8 million.

(UPDATE: Here's another example. Bain Capital Fund X LP reported that it converted $338 million as of the end of 2009. At a 20% tax rate differential, that $67 million in taxes unpaid. Plus deferral.)

Bottom line: Mitt Romney has not paid all the taxes required under law.

(UPDATE: Yes, Romney left Bain in 1999 or 2002. But as part of his severance agreement, he continues to receive interests in these funds, which he has reported on his financial disclosures. In the usual case, a departing partner would receive an economic stake in the GP (Bain Capital Partners X, LP), rather than an economic stake in the LP (Bain Capital Fund X, LP) - representing a payment for the management services he provided in the past. Indeed, because he filed an 83(b) election, we can be sure that he received GP interests as part of his severance agreement, and that he therefore benefited personally from management fee conversions.

(UPDATE: A couple more points. The Romney camp has complained that because Romney was a "blind investor" in the funds after 2002, it's unfair to blame him for any tax dodging. They don't deny that he benefited economically from the fee conversion or the lower taxes that followed. So the question is, can we fairly attribute the tax dodge to Romney?

Romney here is not like a passive mutual fund investor. He helped engineer the funds in the first place. For at least some of the funds, the fee conversion was set in place at the time of the fund's formation - in the case of Fund VII, when Romney was the sole shareholder of the management company that actually waived the fees (2000). It seems reasonable to infer that fee conversions were in place for earlier vintages of Bain Capital funds as well. I haven't yet reviewed all of the Gawker documents, but we are talking hundreds of millions of dollars in tax liability on these funds - one hundred million in Fund IX alone (20% of the $500 million converted), another $70 million in fund X. It is unthinkable that in the 1990s through 2002, when Romney was putting together funds, that he was unaware of the fee conversion strategy, or that he was unaware that he continued to benefit from it today.
snip end quote

Now what I dunno is if this is a felony.

But really? A candidate for the Presidency of the United States is up to his eyeballs in this highly sketchy stuff, tens of millions in Cayman Island accounts, and running on a platform to deregulate Wall Street, and may likely win? We are soooooo screwed.

Here is a link that might be useful: linky


Follow-Up Postings:

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RE: Management Fee Conversion

I heard this story on NPR on the drive home and it's quite astonishing how much money in taxes this guy avoids.

One of the people interviewed mentioned the Wall Street rule which is that if all these investors do it, too much money is in play and the IRS really can't respond.

Here is the gist of the Wall Street Rule:

2) On taxes:
(a) The Internal Revenue Service cannot attack the tax treatment of a transaction if there is a long-standing and generally accepted understanding of its expected treatment.
(b) The Internal Revenue Service is deemed to have acquiesced in the tax treatment of a transaction if the dollar amount involved is of significant magnitude. The Internal Revenue Service warns against relying on 2(a) or 2(b).

Here's another story that will make your hair curl. According to his tax returns Romney's is still "active" in Bain.

But according to his 2010 tax return, when the Internal Revenue Service comes calling in April, Romney has a different answer: The presumptive GOP nominee reaps lucrative tax breaks for "active" participation in the private equity firm he founded, as well as a host of other investments.

I just couldn't believe my eyes, then I remembered we are talking about Mitt Romney, liar extraordinaire.

Here is a link that might be useful: source


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RE: Management Fee Conversion

So, the IRS won't go after it because its so much money, and they've been cheating doing it for so long?

Too rich to pay taxes.


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RE: Management Fee Conversion

Well well well.


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RE: Management Fee Conversion

It's a remarkable fact that no matter how much wealth one controls one never wants to relinquish control over any of it.

Like from my little perspective it's easy to think, "wow, if I had millions of dollars a year of income, why would I care if I paid 40% of it in taxes?" Probably I would care, though, because there's always some pet project to be done that I would think more important than what gov will do with the money.


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RE: Management Fee Conversion

Not legal? Really? I suspect that many, many Obama donors will be facing indictments.


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And why wasn't this addressed when the Dems had control of Congress?


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RE: Management Fee Conversion

Posted by pnbrown z6.5 MA (My Page) on
Wed, Aug 29, 12 at 8:28

It's a remarkable fact that no matter how much wealth one controls one never wants to relinquish control over any of it.

"wow, if I had millions of dollars a year of income, why would I care if I paid 40% of it in taxes?" Probably I would care, though, because there's always some pet project to be done that I would think more important than what gov will do with the money.

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Yes, I would think what one thinks about what happens to their money IS important, especially in view that the government is known for wasting people's money.

What is remarkable is the perspective of anyone even considering what someone with money thinks about keeping their money and suggestions that the person with it tries to "justify" why they should keep their own money.

THAT is what is incredulous to me--that someone even considers the thinking process that a person with money has about KEEPING what is THEIRS to begin with, and that others spend time thinking about how they deserve what someone else has, deigns to make assumptions about whether that person "needs" it or not, and how they can take it for their own use.

Perhaps--just perhaps--that after people pay federal income taxes (which almost half do NOT PAY A DIME and some even RECEIVE "earned income credit" funds from the federal treasury) THEY should keep what they have, and perhaps they WANT to control what happens to it. I know that I can make my money work harder and help more people considerably better than the wasteful, flippant, and careless federal government.

Why shouldn't people want to control what happens to what they have worked for?


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RE: Management Fee Conversion

I saw this yesterday on several news feeds... it explains a lot.

The only thing it doesn't explain is why middle to lower class conservatives would consider handing him their one and only vote.


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The only thing it doesn't explain is why middle to lower class conservatives would consider handing him their one and only vote

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Hmmm, because maybe they care more about principles than what's in it for them?


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Perfectly clear why he's trying to hide his tax-returns.

What a low life rich trash.


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RE: Management Fee Conversion

Well, class and morals are not things one can buy with money, so...


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RE: Management Fee Conversion

So--what?


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RE: Management Fee Conversion

Well, class and morals are not things one can buy with money, so...


...it's easy to find out the fakes. Scratch their thin veneer of wanna be classy, and faux manners, and the ugliness of their true colours will show. A mask is a mask--it's bound to come off.


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RE: Management Fee Conversion

They always do, Maddie... they always do.


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RE: Management Fee Conversion

Hens claws and lack of courage.

Politicians in training!


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RE: Management Fee Conversion

I don't think Romney is pretending to be anything that he isn't. He is super-rich and he works for the super-rich.


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RE: Management Fee Conversion

Right now, he is.


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RE: Management Fee Conversion

We can add thief to the list.


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RE: Management Fee Conversion

Well, at least Obama has commented on the bogus nature of carried interest and has stated he would like to see that repealed, while the Republicans have yet to take any stance.

Well, except nominate a candidate for president who made a fortune using the contrived, drive-a-semi-through loophole, and a part of it illegally - if it ever goes to court.


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RE: Management Fee Conversion

Sour grapes.


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RE: Management Fee Conversion

Yep those folks are just jealous. That is always the "defense".


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And yet when pressed, not a single poster on this forum is able or willing to defend carried interest. But they'll vote for a guy who worked that system to a tee, clear to anyone who cares that he broke the law, while making himself hundreds of millions of dollars, much of it sequestered away in the Caymans.

You can't make this stuff up. All you get is WAWRGAABBLE OBAMA OBAMA WAEREAONGOBBLE


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RE: Management Fee Conversion

They're just defending one of their own. Birds of a feather.

Let's not forget how vast amounts of Romney's profits came about: Murder Squads. Nothing but deafening silence on that from the morally impoverished.


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"Hmmm, because maybe they care more about principles than what's in it for them?'

The why do they sit silently by when deliberate lies are told? Maybe I just have a very different idea about what constitutes principled.


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Looks like the NY AG is looking into this now - apparently, it hasn't been tried in court to find out if its legal or not.

"The New York attorney general is investigating whether some of the nation's biggest private equity firms have abused a tax strategy in order to slice hundreds of millions of dollars from their tax bills, according to executives with direct knowledge of the inquiry.

The attorney general, Eric T. Schneiderman, has in recent weeks subpoenaed more than a dozen firms seeking documents that would reveal whether they converted certain management fees collected from their investors into fund investments, which are taxed at a far lower rate than ordinary income.

Among the firms to receive subpoenas are Kohlberg Kravis Roberts & Company, TPG Capital, Sun Capital Partners, Apollo Global Management, Silver Lake Partners and Bain Capital, which was founded by Mitt Romney, the Republican nominee for president. Representatives for the firms declined to comment on the inquiry.

Mr. Schneiderman's investigation will intensify scrutiny of an industry already bruised by the campaign season, as President Obama and the Democrats have sought to depict Mr. Romney through his long career in private equity as a businessman who dismantled companies and laid off workers while amassing a personal fortune estimated at $250 million.

Some executives at the firms said they feared that Mr. Schneiderman, a first-term Democrat with ties to the Obama administration, was seeking to embarrass the industry because of Mr. Romney's roots at Bain. Others suggested that the subpoenas, which were issued by the attorney general's Taxpayer Protection Bureau, might be part of an effort to recover more revenue for New York under state tax law. The attorney general's office does not have the power to enforce federal tax laws.

A spokesman for Mr. Schneiderman declined to comment.

The tax strategy - which is viewed as perfectly legal by some tax experts, aggressive by others and potentially illegal by some - came to light last month when hundreds of pages of Bain's internal financial documents were made available online. The financial statements show that at least $1 billion in accumulated fees that otherwise would have been taxed as ordinary income for Bain executives had been converted into investments producing capital gains, which are subject to a federal tax of 15 percent, versus a top rate of 35 percent for ordinary income. That means the Bain partners saved more than $200 million in federal income taxes and more than $20 million in Medicare taxes.

The subpoenas, which executives said were issued in July, predated the leak of the Bain documents by several weeks and do not appear to be connected with them. Mr. Schneiderman, who is also co-chairman of a mortgage fraud task force appointed by Mr. Obama, has made cracking down on large-scale tax evasion a priority of his first term.

As a retired partner, Mr. Romney continues to receive profits from Bain Capital and has had investments in some of the funds that documents show used the tax strategy. - snip -

Complete article at the link

Hey, somebody needs to pay for for the Navy, Army, Air Force, Marines, Coast Guard, Border Patrol, the Veterans Administration. I'd think these guys could pull their weight.

Here is a link that might be useful: link


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RE: Management Fee Conversion

Well, there is more than one kind of principle, so that must be it... while some of us are thinking in terms of ethical behavior, others are thinking in terms of assets.

And then there's that never answered question... when is enough, enough?

How can people look around at the suffering going on everywhere, and not feel the slightest tingle of empathy... as they hoard away billions and slip through barely legal cracks to keep just a few more pennies for themselves? I just can't comprehend that mindset.

If I have $2, and someone needs one... I happily give them one. So, I can't comprehend weaseling out of paying the same rate on taxes as everyone else does. Even at the higher rate, it still leaves more money than one family could spend in a lifetime... so I'm having a tough time seeing why the tax rates should be different, meaning lower, for the wealthy.


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Chirp chirp chirp.

Imagine for a minute there...had Obama done this, the resident rightwingers would be foaming at the mouth.


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Imagine, if a conservative had posted a photoshopped photo of the Democrat Convention and called it a "lucky snapshot" the resident leftwingers would be rabidly foaming at the mouth!


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Yes yes we all know cheating is only bad when it's about a handful of foodstamps. When Romney does it, it's awesome.


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And why wasn't this addressed when the Dems had control of Congress? (I don't get the question)
They aren't the IRS nor are they Attorney General of any state?


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Well, both parties rake in campaign contributions hand over fist from these hedge fund, leveraged-buyout crooks job creators.


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It's an understanding that everyone in bothe parties knows exactly how every loophole works & is working in advance of an investigation. Since Demi worked in the field before Demi has the IRS always known that corporations use this practice & have they always thought the practice was illegal.


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RE: Management Fee Conversion

I do not know the answer to your question, Labrea.

I am quite sure that the IRS is aware of just about every practice, allowed and not allowed, to minimize tax payments.

It seems to me though, that if the practice was indeed illegal, there would be examples made of those breaking the law and the practice would largely be discontinued.

I'd have to look up case law and IRS regs--I don't have easy access to that anymore.

I was employed in the Criminal Investigation Division which involved failure to file and fraudulent returns, not "loophole" questions which the audit division handles.


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