In the wake of news reports last week that presidential contender Mitt Romney owns an individual retirement account worth as much as $101 million, questions are growing over how it could have gotten so big when contribution limits are capped at $5,000 or $6,000 a year.
Tax lawyers and accountants suggest an answer: Romney may have made use of an Internal Revenue Service loophole that allows investors to undervalue interests in investment partnerships when first putting them into an IRA. These assets can produce returns far in excess of those that could be generated from other investments made at the capped level.
An investor could even set an initial value for a partnership interest at zero dollars, because under tax regulations an interest in a partnership represents future income, not current value, said Chris Sanchirico, co-director of the Center for Tax Law and Policy at the University of Pennsylvania Law School.
Whether Romney used this technique, which is legal, when he put partnership interests into his IRA is a question that won't likely be answered when he discloses his 2010 tax returns on Tuesday.
Romney's IRA, valued at between $20.7 million and $101.6 million, as reported by The Wall Street Journal last Thursday, holds stakes in 13 investment entities run by Bain Capital, the private-equity firm he cofounded and led for 13 years.
"One possibility for its size is that he put his Bain partnership interests into the IRA and valued them at a very low number," said David Weisbach, a law professor who focuses on tax at the University of Chicago Law School.
Andrea Saul, a spokeswoman for the Romney campaign, declined to respond to emails and calls.
In the wake of growing scrutiny of his personal wealth, Romney, one of the wealthiest contenders ever for the White House, told Fox News host Chris Wallace on Sunday that on Tuesday he would release his 2010 tax returns and estimates for his 2011 return.
The release will not provide much insight into his IRA. That is because a personal income-tax return shows IRA contributions and withdrawals only for the year of the return, and not for previous years, and does not show whether any contributions were in the form of undervalued partnership interests. While an IRA investor can sometimes be required to file a separate return for the IRA, it is unclear whether Romney intends to release any such returns.
Romney's personal financial summary, disclosed last August under federal election rules, shows that his IRA holds his most lucrative investments, which are stakes in partnerships run by Bain Capital. Those stakes include Bcip Trust Associates III, a Bain fund that is his single largest investment, with assets valued at $5,000,001 to $25,000,000. Bcip Trust Associates III produced income to Romney's IRA of over $5,000,000 over 2010 and through August 12, 2011, according to the summary.
Robert Stack, head of international tax at law firm Ivins Phillips & Barker, said it is possible that Romney's IRA grew so large not only because of an increase in the value of the funds in which it invests but also through lucrative profits, typically 20 percent of investment gains per year, that funds can generate for their general partners.
It is not known whether Romney is a general partner in the Bain funds, meaning invested in the partnership responsible for managing the funds, or simply an investor in the funds. The Romney campaign has declined to comment on this issue.
The general partners' cut of the profit, known as carried interest, is taxable each year if the funds in which the IRA is invested earn certain management fees or borrow to make their investments. Tax lawyers say they want to know whether Romney's IRA holds any carried interest and whether it has paid tax on it - something not disclosed in his personal financial summary or on a federal income tax return. "In the context of a $100 million IRA, that is what we would want to know," said David Miller, a tax lawyer at Cadwalader Wickersham & Taft.
The average IRA held by Americans holds $42,500, according to the Investment Company Institute, a trade group. While the Romney campaign has said that some of his IRA consists of retirement savings rolled over from previous plans, accountants say rollovers would not likely explain the size of his IRA.
"Even if he rolled over a 401k, with the annual caps on contributions, you're still only talking about a few million dollars," said Robert Green, an accountant who is founder of Green Trading, a tax and accounting firm that caters to the investment industry. Last year, individuals could contribute a maximum of $16,500 a year to their 401(k) plans.
Tax lawyers say it is also important to know whether Romney's IRA holds stakes in Bain funds directly, or through related, offshore entities.
These entities, commonly used by tax-exempt investors such as Romney's IRA, legally allow the investors to avoid having to pay a special tax, known as the unearned business income tax, or UBTI.
While the Wall Street Journal suggested on Thursday that avoidance of the special tax was a big reason for the size of Romney's IRA, some tax lawyers said that its size might simply reflect the extreme profitability of a carried interest held by the IRA. "The best guess is that he put the carried interest into the IRA," Miller said.
Romney's IRA produced income of $1.5 million to $8.5 million over 2010 and through August 12, 2011, according to his financial summary, but it is unknown what, if any, taxes the IRA may have paid on its carried interest. Saul, Romney's campaign spokeswoman, declined requests for comment.
(Reporting by Lynnley Browning; Additional reporting by Gregory Roumeliotis; Editing by Amy Stevens, Eddie Evans and Carol Bishopric)