Renaissance explores settlement as IRS seeks billions in taxes

Hedge fund giant Renaissance Technologies is in talks to resolve a dispute with the Internal Revenue Service over a tax maneuver that saved its owners billions of dollars.

James Simons, the firm’s billionaire founder, and Robert Mercer, an influential backer of President Donald Trump, are among Renaissance insiders who profited from the maneuver and would bear the cost of a settlement. A resolution may entail “substantial” additional payments from investors in the flagship Medallion fund, the firm said in a December letter seen by Bloomberg.

The case is among the largest ever handled by the IRS, pitting it against some of the nation’s biggest political donors. A bipartisan Senate panel estimated in 2014 that Medallion investors underpaid their taxes by some $6.8 billion over more than a decade by masking short-term gains as long-term returns.

James Simons, Renaissance Technologies Corp, chairman and president, speaks during a reception at the American Museum of Natural History in New York
James Simons, Renaissance Technologies Corp, chairman and president, speaks during a reception at the American Museum of Natural History in New York, U.S. Photographer: Jin Lee/Bloomberg

Last month, Renaissance for the first time identified the IRS dispute as a potential risk in its annual registration with the Securities and Exchange Commission. The IRS is seeking billions of dollars in back taxes, penalties and interest.

Although the firm acknowledged the possibility of a settlement in the letter, it said it continues to believe the IRS is wrong. A spokesman for East Setauket, New York-based Renaissance declined to comment. The IRS is prohibited from discussing individual cases.

Back Taxes

Medallion, which is open only to current and former Renaissance employees, has generated returns of about 40 percent after fees for decades by using computers to spot market patterns. It’s distinct from the funds Renaissance makes available to outsiders, such as the Institutional Equities Fund.

Medallion earns most of its money through short-term trading of securities and other assets. Such earnings typically get taxed at the same marginal rate as salary. The tax code rewards longer-term investments with a preferential, lower rate.

The dispute centers on transactions the firm carried out with Barclays Plc and Deutsche Bank AG between 2000 and 2015 that had the effect of transforming short-term trading gains into long-term returns. Rather than own securities directly, Renaissance instructed the banks to buy and sell them within a portfolio of assets. It then bought an option from the banks tied to the portfolio’s performance.

Medallion typically held each option for more than a year, and reported the earnings from them to the IRS as long-term capital gains.

Testifying before a Senate subcommittee in 2014, Renaissance officials said taxes weren’t the primary reason for entering into the options deals and that outside tax lawyers signed off on the arrangement.

Seeking Penalty

The IRS argues that the short-term tax rate should have applied. It’s pursuing back taxes from Medallion investors for the 2005 to 2015 tax years, the letter states. Those years account for at least $30 billion of the $34 billion in profits sheltered by the option trades, Senate records show.

The IRS is also seeking a 20 percent penalty on underpayments, an amount that could reach more than $1 billion.

While Renaissance told investors as recently as 2014 that it planned to “vigorously contest” the IRS’s actions and predicted a “favorable resolution,” those phrases aren’t repeated in the December letter.

Simons, 80, whose net worth is estimated at $16.7 billion by the Bloomberg Billionaires Index, is among the largest donors to Democratic candidates. Mercer, 72, was co-chief executive officer at Renaissance from 2010 through 2017. He won fame for his financial support of Trump during the 2016 campaign and his ties to Stephen Bannon, the former White House chief strategist.

The case has been under review by the IRS Office of Appeals since 2017. If no resolution is reached, Renaissance could ask a court to review the agency’s decision.