FORTUNE -- Mitt Romney paid taxes at a much lower rate than did many other Americans, but he may have paid at a higher rate than his former colleagues at Bain Capital.
The underlying issue is management fee waivers.
In short, private equity funds receive annual management fees that are used to cover overhead like salaries and office leases. Typically 2% of capital commitments, paid by fund investors (pension funds, endowments, etc.). Certain firms like Bain Capital, however, sometimes "waive" (i.e., redirect) the management fees directly into the funds -- in lieu of certain co-investments that are required of firm executives. And if those funds make profit for the waived year, the firm executives get to pay capital gains tax rates that are substantially lower than ordinary income rates. As for covering overhead, Bain taps management fees from non-private equity funds (hedge funds, venture capital funds, etc.).
It's a controversial practice that recently piqued the interest of New York Attorney General Eric?Schneiderman, although the IRS didn't bring any actions following a similar probe five years ago. No matter what, it means lower taxes for private equity executives (at least in terms of percentage paid).
Okay, back to Mitt Romney.?The Washington Post today wrote about Romney's retirement package from Bain Capital:
Under the terms of the retirement package, as described by Romney and Bain executives, he would benefit from Bain business deals made through Feb. 11, 2009 ? 10 years to the day after he left Boston to run the Olympics.?He would receive the 2 percent management fee as well as a share of the carried-interest profits that Bain made from acquiring and later reselling companies.
Then came the following statement from Brad Malt, a Boston-based attorney who manages Romney's blind trust:
"Investing fee income is a common, accepted and totally legal practice.?Governor Romney's retirement agreement did not give the blind trust or him the right to do this, and I can confirm that neither he nor the trust has ever done this, whether before or after he retired from Bain Capital."
It seemed to be a contradiction. If Mitt Romney was entitled to a cut of management fees waived by Bain for the purpose of reducing taxes, wouldn't that mean that Romney's percentage of the fees were also waived. And, if so, how could Malt claim otherwise?
The answer is that Romney's arrangement was a bit different than the Washington Post suggests. Rather than being entitled to a percentage of management fees from each Bain Capital fund, sources tell me that Romney actually received a percentage of all Bain Capital commitments -- regardless of individual fund waivers.
In other words, imagine that Bain Capital is currently managing $20 billion in fund commitments across its entire universe of strategies. And then imagine that this includes $10 billion of private equity fund commitments, on which Bain Capital waived fees for 2012. Romney still would be entitled to his cut based on the $20 billion figure, not on the $10 billion figure. And he should be paying taxes on that money at an ordinary income rate.
To be clear, Romney also receives a percentage of each fund's carried interest (i.e., investment profits) on which he would pay capital gains rates. But he does not get to effectively convert his management fees into partnership profits, as do those still working at Bain Capital. As such,?Romney actually should pay a higher tax rate on his Bain-related earnings than do others who are entitled to management fee income.
For more specifics, of course, we'd need the Romney campaign to release a few more years of tax returns...
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Source: http://finance.fortune.cnn.com/2012/09/04/mitt-romneys-higher-tax-bill/
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