Did Bain Capital Execs Break The Law Using A Common Tax Avoidance Strategy?
Imagine you receive a cash bonus at the end of every year. If late in December you ask your employer to alter the arrangement and provide the bonus in stock rather than cash, the IRS could cry foul. Since the bonus had already been earned (if not actualized) tax authorities might view the new arrangement as equivalent to cash compensation that was then used to purchase stock. That compensation would be taxed as ordinary income before it could be plied into an investment.
So timing matters.
“They took what was their compensation income and rolled it into carried interest, after that compensation had already been earned, very late in the year,” Kleinbard said. “I think the critical question is how late in the day — was the income already earned? I think the answer is yes. And I would’ve advised against that kind of structure. … Other firms either didn’t do it at all, or they did it the right way, by waiving their management fees in advance. You say in 2012 that you will waive your management fees in 2013.”
Victor Fleischer, a law professor at the University of Colorado — raised a similar objection after Gawker.com posted years worth of Bain financial documents that revealed Bain’s practice of rolling its management fees into carried interest. Schneiderman’s investigation began before the Gawker document dump, according to the Times.
The New York probe cuts right to this issue. It’s premised on the notion that when firms convert management fees into either carried or capital interest, they’re illegally avoiding state taxes. In the case of a capital interest conversion, the fees are simply not taxed at all. In the case of a carried interest transition, execs can defer taxation, and thus potentially reduce their tax burden.