In it, but not of it. TPM DC
Tax law experts we spoke to explained to us how an IRA could in theory reach the size of Romney's. And though it's impossible to know -- without more information from Romney -- whether he's avoided any taxes, the experts explained how a massive IRA could easily benefit from legal avoidance of one obscure U.S. tax.
First, on size.
As Reuters reported when the controversy first emerged in January, Romney's IRA likely thrives on a strategy of gaming the valuation of investment partnerships in a way that yields outsized dividends.
"[A]n Internal Revenue Service loophole ... allows investors to undervalue interests in investment partnerships when first putting them into an IRA," Reuters reported. "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."
That's only one half of the equation. According to Daniel Shaviro, a tax expert at New York University, those investments would have to thrive.
As Shaviro explained, "borrowing to hold a stock portfolio is not necessarily a magic formula for wealth, or all of us would go out there and borrow as much as we can to invest in the stock market. The key, presumably, is that the stocks the IRA held performed extremely well (and that the IRA could hold more of the high-performing stock once it borrowed than if it just used the IRA contributions."
There's a third variable too. Romney's campaign has publicly insisted that none of Romney's foreign investments have allowed him to avoid U.S. taxes. But the campaign has persistently declined to answer questions about a specific, but obscure tax, that Romney's IRA may have helped him circumvent.
The tax is called the unrelated business income tax (UBIT). It can be triggered when tax-exempt entities (including IRAs) borrow to make investments. But as Shaviro imagined it, "Rather than borrowing to hold investment assets, the U.S. tax-exempt [the IRA] creates a [fund] in the Caymans and the entity then borrows to hold the investment assets. So all that the US tax-exempt ends up getting is dividends... and it hasn't literally borrowed to get them at all. Hence, no UBIT."
In other words Romney's IRA may hold stock in Romney's offshore funds, those funds could have levered up and yielded huge returns to the IRA. That would allow Romney not just to circumvent the annual contribution limits, but to avoid a 35 percent tax that would have kicked in if the IRA had taken on the debt-financed investments directly.
For a more technical treatment of this strategy, see pages 40-48 of this 2011 paper (PDF) by David Miller.
On a campaign conference call in January, Romney's trustee promised to investigate whether Romney's IRA included investments that allowed him to avoid the UBIT. Neither he nor the campaign ever provided an answer.