The Brass Tax of Politics

Romney’s Returns: Phantom Income and Phantom Reporting

While Mitt Romney’s tax rate has been calculated to be around 14%, there are a few unreported factors that account for the small percentage. Additionally, as will be detailed below, Mitt Romney paid taxes on $1 million + in income that does not exist. As a lifelong CPA, I was asked to review it for several media outlets. First, let me say that his return is standard, normal, well prepared, and detailed, with nothing unusual given the scope of his assets. That being said, his tax return is 203 pages. Roughly ½ – ¾ of the pages have nothing to do with tax calculation at all. They relate to the ridiculous and over burdensome compliance of several different natures. These include:

  1. All foreign owned investment companies
  2. Details of amounts transferred to foreign investments
  3. Disclosure of any transaction of anything done that looks like it might be a transaction involving something listed by the IRS as an abusive tax shelter.

For instance, some of his tax shelters involve the use of foreign exchange trading. So, if you have foreign investments with foreign exchange trading, you risk the IRS saying you have characteristics of an abusive tax shelter. His are not; they all fall under broad categories, but in order to safeguard against any appearance of impropriety, he spent the majority of his return providing excessive documentation. However, these pages have nothing to do with his tax rate calculation.

Now, his Adjusted Gross Income (AGI) isn’t exactly as it seems. After you arrive at the AGI, you then subtract your deductions, and then you subtract your exemptions, and then, if you are liable for the AMT you adjust with your add-backs. Then, you have your general income tax rate. However, you are not quite done. One thing in particular with Romney’s return is the foreign tax credit, which is a credit you get for earning income abroad. How it works is that you pay foreign tax on foreign income and then you get a credit on your federal return for having already paid tax on that income. Romney’s credit is $130K. $750K of his income was earned abroad, and so he got credit for the $130K he already paid. This figure was then subtracted from his AGI which makes his AGI look smaller (hence a smaller percentage figure).

Additionally, his AGI was reduced by paying a lot of Massachusetts taxes. State taxes are deducted when calculating taxable income, but then, because of the AMT, some of it was added back. Also, as has been reported, Romney made a large amount of charitable contributions, which further reduced his tax rate. These contributions were made at his discretion – he tithed and then some. His AGI was reduced by that total amount. So, those are the key items that factored into his smaller percentage.

However, the most stunning information on his return is the fact that, due to inequities inherent our tax code, Romney paid taxes on more than a million dollars of income that didn’t exist. How is this possible? When you have hedge fund investments, rather than reporting and paying taxes on profit, the IRS requires you to break it up into component parts. For Romney, those component parts are interest, qualified and non-qualified dividends, short term gains, and long term gains. These are all things that contribute to the positive side of calculation. On the negative side, you have interest and expense. The net of all those you would think he’d pay taxes on, except for one thing.

From the income items, off comes the subtraction for interest. However, all of the other expenses that reduce profit – which, with hedge funds,  include virtually all operation expenses to earn income, including fees to the operators – are required to be recorded as miscellaneous itemized deductions.  You cannot deduct your share of expenses unless that amount exceeds 2% of your AGI. What’s worse, even if your expenses do exceed the threshold, and you are subject to the AMT you can’t deduct them at all. This inability to deduct necessary expenses incurred while generating that income means that Mitt Romney paid taxes on $1.017 million of income that does not exist.

As I have written on the subject before, regardless of whether a taxpayer is wealthy or not, the fact that the tax code has a floor for deducting the cost of earning income is an injustice that should be amended. You would think that someone would wonder about a tax law that requires a taxpayer to pay taxes on $1 million more of income than he actually earned. But alas, that is not the case.

After being interviewed by three agencies (Bloomberg, NYDaily News, and CBS Evening News), and extensively explaining the nuances with Romney’s AGI and this particular income item, none of the media chose to report it. Curious, I sent this information off to some folks with whom I have worked at Fox Business, but received no reply. I then communicated with a reporter from the Boston Globe, Ms. Beth Healy, who reported erroneous information on this subject in one of her articles, and offered to explain to her the misinformation. After this polite exchange of emails, she never followed up with the phone call she offered to make

. Only choosing to report the general figure of total income tax paid doesn’t effectively tell you the whole story. But perhaps the greater story here — more than the fact that Romney paid taxes on $ 1 million+ worth of income that doesn’t exist — is that five news agencies chose not to discuss how Romney paid “more than his fair share of taxes”. Perhaps doing so would challenge two prevalent narratives 1) hedge funds are bad and 2) the rich should pay more. Update: See how this story relates to the July 3 coordinated media smears on Romney’s finances by the WaPo and Politico

Comments

  1. angienc says:

    Nice information, explained very clearly. Unfortunately, I seriously doubt the members of the MSM can understand it, especially since it doesn’t really help Obama.

  2. Thanks for the information. I think the point is not what Romney paid in taxes, but are there any potential conflicts of interest. This may be the first time that a person hoping to run for the highest office in the land has such a large amount of their business interested invested in overseas businesses and instruments. The Romney folks can use this as an advantage, but they seem to be at a lose on what to do. It does not help that he has not filed his taxes yet.

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