A few years ago, I was buying gold likeso many others. I did this by purchasing shares in a Canadian mutual fund company that held bullion. I sold my shares in 2011 for a small capital gain. At first, I thought I would pay tax at the low 15 percent capital gains rate, or perhaps at the higher rate for collectibles, but as I researched the rules on taxation of foreign-based mutual funds, I determined I would have to pay tax on my profit in the highest bracket for ordinary income of 35 percent.
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I am a small-town practitioner and my clients are unsophisticated middle-class taxpayers. The 35 percent rate on foreign investment companies was news to me.
What made the circumstances more frustrating was my subsequent discovery that there is an election I could have made using an obscure IRS form -Form 8621- in the year I acquired my mutual fund investment. That election would have made it possible to avoid the 35 percent rate.
Several months ago, the Mitt Romney campaign made his 2010 return public, along with an estimate for 2011. I had no intention of reviewing it, but sometime in mid-August, I linked to the return from a news story about the $4.8 million capital loss carryover on his 2010 Schedule D. What I found was a document of over 200 pages including IRS forms and supporting schedules.
Yes, there was that $4.8 million capital loss carryover on Line 14 of the Schedule D, but what struck me next was that so much of the return was comprised of Form 8621. There are 122 pages of actual IRS forms in the document, and of those, 34 pages are multiple copies of Form 8621 electing out of paying the 35 percent rate.
I counted 63 pages of Internal Revenue Service forms directly related to foreign transactions. I also found 12 pages of Form 8886 filings, which is filed to disclose what the IRS terms "abusive tax shelters and transactions." These filings likely relate to foreign investments. That means that 75 of the 122 pages - well over half - are devoted to foreign activities.
I stopped for a moment to ponder the absurdity of a tax system that allows a taxpayer to participate in an abusive tax shelter as long as the activity is disclosed.
Continuing to peruse the return, I noted a Form 5884 and a Form 3800, four pages altogether, reporting a transaction in the amount of only one dollar: a flow-through from a partnership or trust of a one dollar work opportunity jobs credit. "Good work creating U.S. jobs, Mitt," I muttered under my breath.
Then I turned to the supporting statements.
WHICH COST TO PAY?
Before I describe what I found on the supporting statements, I should provide some background.
Experts had noted that at 13.9 percent of total income, Romney's federal tax rate in 2010 is lower than for most middle-class taxpayers, who, in addition to income tax, pay a disproportionate amount of federal payroll taxes.
Some discussion in the media revolved around that $4.8 million capital loss carryover appearing on the 2010 Schedule D, which is a clue to what we would find on his 2009 tax return. Romney was able to offset all of his capital gains in 2009 and still have a $4.8 million capital loss to carry into the 2010 year.
Romney had refused to release tax returns for years prior to 2010, despite a tradition of presidential candidates making several years public. (As of press time, he still hadn't released any prior returns, but had announced that he would be releasing his 2011 return.) The day I linked into the 2010 return, Romney announced to the press that he had personally reviewed his returns over the prior decade. "I did go back and look at my taxes and over the past 10 years," Romney said. "I never paid less than 13 percent. I think the most recent year is 13.6 or something like that. So I paid taxes every single year."
Romney did not specify what kind of taxes he paid in prior years that added up to more than 13 percent. The 13.9 percent reported in news stories for 2010 was the federal income tax plus the self-employment tax divided by total income. Romney's 2010 federal income tax liability is computed under the Alternative Minimum Tax rules, net of a $77,565 foreign tax credit. Foreign tax credits reduce federal tax liability on a dollar-for-dollar basis. Therefore the $77,565 represents foreign taxes paid in addition to the U.S. taxes paid, and, if counted, would increase the rate paid from 13.9 percent to 14.25 percent.
I stopped to wonder if Romney was counting the foreign taxes paid in prior years when he said he always paid more than 13 percent.
Why not release the returns prior to 2010? ABC News commentator George Will summed it up best. "The costs of not releasing the returns are clear," Will said. "Therefore, he must have calculated that there are higher costs in releasing them." Political pundits speculated he may have paid no or very little federal income tax in prior years.
BACK TO THE RETURN
So these were the events transpiring on the day I linked into the 2010 return. I made my observations about the IRS tax forms, described above, and then turned to the supporting statements.
There are 69 supporting statements. Right away, just starting to turn the pages, I found much of interest. For example, Statement 2 reports cancellation of debt income. What I found on Statement 4 really got my attention. Statement 4 discloses refunds received from state governments for years prior to the immediately preceding year (i.e., for years prior to 2009). The states are not disclosed, but there are likely several involved on a tax return of this complexity.
When a tax preparer sees a taxable state refund from prior years on the federal return, the preparer's first thought is that there was a net operating loss carried back from the immediately preceding year and applied in prior years. Many states allow such carrybacks.
How could Romney have generated an NOL in 2009? An NOL generally results when an active trade or business is losing money. Romney is essentially retired. One possibility would be a suspended passive loss deductible in the year the activity was liquidated. Also possible would be a loss flowing through from a Bain entity deductible under the passive loss rules if he could show material participation in the entity for any five of the preceding 10 years. This could be politically damaging, because Bain began aggressively moving jobs overseas within this time period.
I asked myself, if there had been an NOL in 2009, why didn't I see carryforwards of unused charitable contributions on the 2010 income tax return? Charitable deductions cannot be claimed to the extent they exceed 50 percent of adjusted gross income. With an NOL, there usually isn't much AGI on the return. I found the answer on the 2010 return. Due to Romney's high interest and dividend income, there was the potential for a low-seven-figure charitable deduction even in a year with a significant NOL.
I paused to consider the similarities between tithing and taxes. Both are a percentage of income. Romney gives millions to his church and receives back the same spiritual services as the church member sitting in the pew next to him, who may give only several thousand dollars. Romney appears to be willing to tithe at the same rate as other church members, but pays federal taxes at a lower rate than most middle-class taxpayers. The church provides assistance to the needy, but so does the U.S. government, and to a much greater degree.
Other possible explanations exist for the tax refunds from prior years. Perhaps there was an amended return, or a state taxing authority may have held a 2008 filing for review before issuing the refund late. There are several other possibilities.
On balance, though, there was enough there, on Statement 4, to keep me interested. I continued to review the supporting statements, looking for more evidence that 2009 was a loss year, a year in which Romney paid no or little federal income tax.
I kept turning the pages, until I got to Statements 28 through 40, which concern the foreign tax credit. Specifically, on Statement 30 I found evidence supporting an NOL for 2009. On this statement appears the 10-year history of foreign taxes paid and related foreign tax credits claimed, in the passive category, under the regular income tax system. In every year except 2009, Romney claims as a credit the full amount of the foreign taxes paid.
What about 2009? In 2009 Romney claims a zero foreign tax credit and carries the full amount of foreign taxes paid in 2009 over to 2010. This suggests that either he had no foreign taxable income in 2009 or he had no U.S. federal taxable income tax that year. Which one could it be?
I found a possible answer on Statement 35. This statement shows the same 10-year history as Statement 30, again in the passive category, except this time under the AMT. As before, in every year except 2009, Romney claims a credit for the full amount of the foreign taxes paid. The difference is that instead of claiming a zero foreign tax credit for 2009, as was the case on Statement 30, he claims a $71,069 foreign tax credit against his 2009 AMT tax liability.
According to both Statement 30 and Statement 35, foreign taxes paid in 2009 amounted to $81,461. Per Statement 30, however, none of this was claimed as a credit against federal taxes computed the normal way while, according to Statement 35, $71,069 was claimed as a credit against the AMT.
So clearly there was foreign taxable income under the AMT system in every year of the 10-year period including 2009. It's possible that under the regular tax system there was foreign taxable income every year -- except 2009. It's possible. On the other hand, the reason the credit wasn't claimed in 2009 against federal income tax computed the normal way could well be that there was no federal income tax due to an NOL deduction. That would be consistent with the state refunds from prior years that I found on Statement 4.
Using my tax software, I entered a $5.25 million nonpassive loss into a hypothetical Romney 2009 income tax return, with amounts otherwise based on the 2010 year except without the capital gains. I computed zero income tax under the regular system, meaning no need for a foreign tax credit, but found that, on the same return, the AMT was high enough, due to high miscellaneous deductions, to fully absorb the foreign tax credit. It was high enough to absorb $71,069 but not much higher.
TAXES FOREIGN AND DOMESTIC
I found some provocative information on another statement. Statement 32 shows the history of foreign taxes paid, and credits claimed, based on general category income. General category income, on a more typical tax return, would tend to be wages or other earned income.
According to Statement 32, there were no foreign taxes paid or credits claimed in connection with general category income from 2000 through 2006. But such credits appear starting in 2007 and continue through 2009. They cease in 2010. What happened? Did Romney come out of retirement, start earning a wage, and retire again in 2010?
The more likely explanation is that the foreign tax paid on foreign income exceeded the highest U.S. tax that could be paid on the income in the years of 2007, 2008 and 2009. Under those circumstances, passive income flips to general category income.
The foreign tax credit claimed for 2008 is particularly noteworthy. Including the credit on general category income, foreign credits add up to $710,076, considerably more than any of the other years in the 10-year period disclosed.
Given that the foreign tax likely exceeded the U.S. tax on foreign income in 2008, it is possible that the only way Romney could support his claim that he paid more than 13 percent in 2008 would be to count the foreign taxes paid as part of his total tax.
Review of the foreign tax credits led me back to Statement 4 and that large state income tax refund from prior years. Although states do not tend to allow foreign tax credits, they do frequently allow deductions for the foreign taxes paid. The state refunds on Statement 4 might have been generated by a large subtraction on a state return of foreign taxes paid in 2008, rather than by a 2009 NOL, with the refund arriving in 2010 due to a delay in processing.
In summary, the 2010 federal return provides some evidence that the U.S. tax paid on the 2009 and 2008 returns may have been astonishingly low, and that perhaps Romney paid more foreign tax in 2008 than U.S. tax.
It's remarkable the lengths some people will go to avoid income taxes (and many within our profession have acted as enablers), repatriating their investments, committing what feels morally like a kind of tax treason. I know -- all Romney's rich friends are doing it, too. Or did Romney help pioneer this form of tax-motivated foreign investing, just as Bain was in the vanguard of U.S. companies shipping American jobs over sea? I am not sure which would be the most disheartening.
Am I as guilty as Romney? I had that investment in the foreign mutual fund after all. The difference is that I invested in the Canadian mutual fund because, at the time, I was aware of no other way to purchase gold bullion. The type of investment drove my decision to buy a foreign-based mutual fund. With Romney, the foreign investments, in places like the Cayman Islands, are likely tax-avoidance schemes (hence the Form 8886 filings). My decision to purchase a foreign investment increased my tax liability.
(Full disclosure: I contributed my profit from the sale of the Canadian mutual fund to the Obama campaign.)
Harry Bose, CPA, is a partner with read & Bose PC, in Pendleton, Ore.