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How is reporting your income properly a 'tax dodge'?

March 02, 2010

BYRON YORK: Treasury Nominee Profited From Offshore Tax Dodge. Nothing wrong with this — but kinda hypocritical given the Obama Administration’s posturing. Then again, tax hypocrisy from Treasury nominees seems de rigeur for this crowd . . . .

Nice headline, but it's a weak charge. From the York article:

Jeffrey Goldstein, the Obama administration's nominee to be the Treasury Department's Undersecretary for Domestic Finance, worked for a private equity fund that set up offshore shell corporations which allowed investors to avoid U.S. income tax, according to Senate Republican sources. The Senate Finance Committee is set to hold a hearing on Goldstein's nomination Tuesday.

The firm for which Goldstein worked was Hellman & Friedman, and the shell corporations were located in the Cayman Islands. Goldstein, who was at Hellman & Friedman from 2004 to 2008, received income from the offshore investments -- money he was able to enjoy while paying a lower tax rate than most Americans pay on regular income. Goldstein earned what is called "carried interest," which is taxed at the lower capital gains rate rather than be taxed as regular income.

"Carried interests" have been a political football. These are "profits interests" earned by hedge fund an private equity managers. Carried interests work like this: the fund manager doesn't get an initial stake in investor money. If the fund doesn't grow, the manager gets nothing. If the fund does grow, the manager gets a "profits interest" percentage of all the income and capital gains and is taxed the same way as the investors on his cut. Populist politicians say the manager share of capital gains should be taxed as ordinary income, but the tax law is clear: the fund manager reports his share of fund capital gain as capital gain income, taxable at a 15% top rate, unless the law changes. So what's the problem?

The arrangements appear to have been legal, but in the past, prominent Democrats, including President Obama, have strongly criticized such tax-avoidance schemes. On the campaign trail, Obama often denounced "corporate loopholes and offshore tax havens," and last May, he unveiled a plan to reform "a tax code that makes it all too easy for a small number of individuals and companies to abuse overseas tax havens to avoid paying any taxes at all."

So it comes down to a charge of hypocrisy, or something like that. But think about it: what was he supposed to do? The guy got a K-1 from his hedge fund with instructions on how to report the income. Was he supposed to ignore that and report it all as ordinary income? If so, how? Was he supposed to call it self-employment income too? If he reported it differently from the K-1, he'd have to file Form 8082, which invites the IRS to investigate both him and the partnership.

Or was he supposed to report everything the way the K-1 said to, but then do an as-if computation to see what the tax would be under some carried interest tax proposal, and then write a check to the IRS for the additional as-if tax? If so, which carried interest proposal should he follow?

I have little sympathy for politicians, and I expect that Mr. Goldstein's defenders would make the same lame charges if the shoe were on the other foot. Still, as Tim Geithner's example shows, it's hard enough to get politicians to report their income properly. We shouldn't expect them to somehow go beyond that.