A little-noticed decision by the Internal Revenue Service’s appeals unit may spell trouble for legendary investor Jim Simons, who’s embroiled in a multibillion-dollar tax dispute with the agency.
Reviewing the audit of an investment manager in Connecticut, the IRS Office of Appeals rejected a tax-avoidance maneuver involving so-called basket options. That’s the type of transaction at the heart of a separate, larger case involving Simons’s Renaissance Technologies hedge fund. The decision, made public in a
The Renaissance dispute is one of the largest ever handled by the IRS, potentially involving about $6.8 billion in back taxes, according to an estimate by U.S. Senate investigators. The list of those who would probably foot the bill includes Simons, the billionaire Renaissance founder dubbed “The Man Who Solved the Market” in a
Jonathan Gasthalter, a spokesman for Renaissance, declined to comment.
Basket options
In a confidential decision in December, the IRS held that GWA, a Hartford, Connecticut-based company run by hedge fund pioneer George A. Weiss, had under-reported ordinary income in 2009 and 2010 by a total of $527 million through its use of basket options. The decision wasn’t made public until Weiss challenged the action in U.S. Tax Court this year. That case is pending.
Weiss’s firm or its investors could face a tax bill of more than $100 million if they lose, based on the amount of income involved and tax-rate estimates used in the Senate report. They may also face interest and a 20 percent accuracy penalty. Sheri Dillon, a lawyer for Weiss, declined to comment.
The Weiss case is almost identical to the one involving East Setauket, New York-based Renaissance, arguably the most successful hedge fund in history. Both firms bought basket options from Deutsche Bank AG and claimed that the devices lowered the tax rate on some of their profits. Both spent years wrangling with IRS auditors before taking their cases to the agency’s Office of Appeals. It’s that office that issued the final determination against Weiss in December.
The appeals office has more latitude than IRS auditors to negotiate settlements. Renaissance told investors in December that it was “exploring possible ways to conclude this dispute” with the appeals office, including a settlement. But the case was still unresolved as recently as March, according to an update sent that month. By law, the IRS is prohibited from disclosing information about specific taxpayer audits.
Medallion Fund
Over more than a decade, Renaissance used basket options sold by Deutsche Bank and Barclays Plc to shelter some $34 billion of income in its flagship Medallion Fund, cutting the rate paid by investors by as much as 20 percentage points, the Senate Permanent Subcommittee on Investigations concluded in a 2014 report. Medallion is owned almost exclusively by Renaissance employees.
Rather than owning securities directly and booking gains and losses from trading activity, RenTech and GWA would buy an option from a bank tied to the value of a securities portfolio it held. The funds would then direct the bank to buy and sell securities in the portfolio.
The funds treated any profit on options held for more than a year as long-term capital gains, which are taxed at a lower rate than the short-term capital gains that would have been generated by owning the portfolio directly.
Deutsche Bank sold such options to at least 13 hedge funds during the late 1990s and early 2000s, including GWA and Renaissance, according to the Senate report. It’s unclear how many of these funds were audited by the IRS. Weiss’s case appears to be the first dispute involving the options to proceed to court.
Deutsche Bank stopped selling basket options that offered a tax benefit after the IRS declared in a
Business purpose
Weiss founded one of the country’s first market-neutral hedge funds and is known for trading utility stocks. His GWA owns Weiss Multi-Strategy Advisers, which manages $2.7 billion.
In the Tax Court case, Weiss argues that the options had business purposes beyond tax savings: They offered more leverage than was available in a typical brokerage arrangement, while at the same time limiting the firm’s risk of loss.
“The Tax Court will have to parse through these arguments and determine whether these option contracts have sufficient economic significance to be respected for federal tax purposes, or whether they should be disregarded as abusive transactions,” the law firm Mayer Brown LLP wrote in a
Weiss is represented by a team from Morgan Lewis & Bockius LLP that includes Dillon and William F. Nelson, a former IRS chief counsel. Dillon and Nelson have long served as tax counsel to the Trump Organization, the president’s real estate business.
— Zachary R. Mider, with assistance from Miles Weiss and Katia Porzecanski
Bloomberg News
