A Clue Emerges to Romney’s Gift-Tax Mystery
By Mark Maremont
One of the mysteries surrounding Mitt Romney’s taxes is how the former private-equity executive managed to get $100 million into a family trust for his children without incurring federal gift taxes.
A potential clue may be found in a previously unreported 2008 presentation made by a partner at law firm Ropes & Gray LLP, which represents the GOP presidential nominee. It focuses on how private-equity executives could minimize gift and estate taxes by giving family members some of their “carried interest” rights, a major form of compensation that entitles private-equity executives to a slice of the firm’s future investment profits.
This is complicated stuff, but bear with us even if you’re not a tax geek. Much remains unclear about Mr. Romney’s taxes given his limited disclosure and the complexity of his personal finances.
The attorney at Ropes & Gray wrote that in the 1990s and early 2000s estate-planning lawyers “commonly advised” that executives could claim a value of zero on these transfers of carried-interest rights for federal gift-tax purposes. He said the practice ended by 2005.
Gifts of carried-interest rights are common, but several estate-planning attorneys at major New York firms said they are puzzled by the claim that the rights ever could have been valued at zero, particularly at an established private-equity firm. They said long-standing rules require taxpayers to value all gifts at fair-market value, or what a willing buyer would pay a willing seller.
In response to a reporter’s questions, a Romney adviser said the presentation by the Ropes & Gray lawyer was aimed at educating other attorneys about industry practices, not a description of Ropes & Gray’s advice to clients. Based on the presentation, the adviser said, “you should not assume” that was the firm’s advice to clients or that Mr. Romney’s gift-tax returns ever valued carried-interest rights at zero.
The adviser declined to address how Mr. Romney actually did value such rights, or whether the rights were given to the trust. The adviser declined to answer other questions about the family trust.
Ropes & Gray long has been the main outside counsel for Mr. Romney’s former private-equity firm, Bain Capital. The Boston law firm’s chairman, R. Bradford Malt, is the trustee of the Romney family trust, and handles Mr. Romney’s other finances through blind trusts.
The Romney family trust was created in 1995. A campaign official several months ago referred to it as worth “roughly $100 million.”
In an email to The Wall Street Journal, the Romney campaign earlier this year said that the candidate had never paid gift taxes on transfers to the family trust, saying “the original contribution and all subsequent contributions have been under the limit on lifetime gifts.”
Federal gift taxes are intended to ensure that people don’t evade estate taxes by giving substantial sums to their heirs. At the time the Romney family trust was created, the lifetime limit on gifts was $600,000 and until recently was $1 million. The tax on gifts exceeding the maximum has ranged between 35% and 55% since the late 1990s.
Because Mr. Romney no longer owns the assets in the trust, the sums held in the trust aren’t included in the campaign’s estimate that Mr. Romney is worth between $190 million and $250 million. But Mr. Romney and his wife, Ann, include the trust’s income on their tax returns and pay taxes on it.
Carried-interest rights, also known as profits interests, entitle private-equity executives such as Mr. Romney to a slice of any investing profits they produce for their investors. Although Mr. Romney ceased day-to-day management of Bain in 1999, as part of a retirement agreement he was given carried-interest rights in Bain funds formed before February 2009.
The Romney campaign has estimated that carried-interest income produced $12.9 million of the $42.5 million in total income reported by the Romneys in their 2010 and preliminary 2011 returns.
The most common time for private-equity executives to give away carried-interest rights is when a new fund is being formed. Because the nascent fund may never produce gains, attorneys say they can legitimately claim the rights have a low value for gift-tax purposes.
Jay Waxenberg, an estate-planning attorney at Proskauer Rose LLP in New York who advises private-equity executives, said valuations “tend to be very low,” but he has never known anybody at an established firm claim a zero value.
“If you make a transfer, it’s supposed to be at fair-market value,” Mr. Waxenberg said. “That’s been true forever,” he said, or at least since the 1950s.
The Romney campaign won’t discuss whether Mr. Romney transferred any of his carried-interest rights to the family trust. There are signs in Mr. Romney’s tax returns that the trust might be reaping carried-interest income from Bain funds, including some formed prior to 2005.
In its 2010 tax return, the trust reported about $2.7 million in long-term gains from Bain entities with names such as “BC PTRS VIII” and “BC PTRS ASIA.”
Former Bain employees said most of the income from entities with such names would likely be from carried-interest rights. They said Bain employees invested their own money in deals, but mostly through entities with names that started with BCIP. The family trust reported about $1.8 million in long-term gains from “BCIP III” and similar entities.
In his 2008 presentation, the law firm partner, Marc J. Bloostein, said the basis for believing that carried-interest rights could have a zero gift-tax value stemmed partly from a 1993 IRS ruling related to income tax treatment of the rights. The IRS said taxpayers could claim the rights had no immediate value when they were received, but would have to pay capital-gains tax on any income that later flowed from them.
Mr. Bloostein indicated that gift-tax valuation practices changed by 2005, saying that although there was once “reason to think” that a zero valuation could be claimed, “it has become clear” that fair-market value is the correct standard and “it is advisable to engage a professional appraiser.”
Because appraisers typically apply a discount for risk factors and other items, Mr. Bloostein wrote, a carried-interest right expected to bring in $2 million of income could be valued for gift-tax purposes at $200,000. Mr. Bloostein didn’t respond to a request for comment.
Scott A. Nammacher, a managing director at Empire Valuation Consultants in New York, said he frequently gets hired to value carried-interest rights. He said he has heard from some legal clients that they used to value the rights at zero, but around the mid-2000s these attorneys were “getting concerned” and asked his opinion.
“I said, if it has zero value, I’d be happy to buy some.”
If Mr. Romney released more than the two years of tax returns he has disclosed, the matter may still not be cleared up. Gift tax returns are filed separately.
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