Romney’s Tax Wrinkles

Apart from Mitt Romney’s famously low tax rate, he appears to have taken advantage of at least two other tax wrinkles to cut his bill to the IRS.

First, the trusts that he set up for his children are so-called “grantor trusts,” which means that the income from those trusts is consolidated with Romney’s returns and the tax due on the trust’s income is paid by him, rather than by the trust. The significance is that by paying the taxes on the trusts’ income, Romney is effectively transferring millions of dollars a year of additional money into those trusts that will not be subject to inheritance tax.

Second, many have wondered how he came to have a nine figure IRA, when IRA contributions are limited to a few thousand dollars a year. My guess is that he put some portion of his Bain carried interest into the IRA by assigning a nominal valuation to it. As the carried interest was realized, the size of the IRA would have grown exponentially. The advantage of this is that Romney avoided paying any tax on carried interest in his IRA — not even the famous 15%. The disadvantage is that when he starts to take money out of it, that money will be taxed at full ordinary income rates, currently 35%. So if Romney put some of his carried interest into the IRA, he was betting that his ability to compound that money during the years that all taxes were deferred (while it was in the IRA), outweighed the higher taxes that he will eventually pay.