Under American law, U.S. investors must pay taxes on profits made from offshore investment funds. However, U.S. investors may be able to defer those taxes until later as they bring the profits into the U.S., depending on how the fund is structured, said Kevin Packman, chairman of his firm's offshore compliance team at Holland & Knight of Miami.
Some hedge fund and private equity managers route IRA retirement holdings through an offshore entity set up as a "blocker corporation," an affiliate of a private equity fund that acts as a way-station, storing the retirement funds while investing an identical amount in the actual fund. This complicated maneuver allows the investor to defer paying a 35 percent tax on earnings that the IRS considers "unrelated business income," said Michael J. Graetz, a Columbia University law professor and an authority on national and international tax law.
The 35 percent tax is aimed at pension funds, university endowments, hospitals and other nonprofit organizations when they invest in private equity funds that borrow large amounts of money to buy other companies. But nonprofits can use the offshore blocker funds to defer those tax payments, and similarly, IRA accounts can be routed through blocker accounts, depending on how tax plans are structured, Graetz said.
"One of the major functions of tax planning is to defer payments and deal with them down the road instead of today," Graetz said. "For an IRA account, it's not so much a tax rate game as it is a timing game."
Romney's other offshore-based investments would not benefit from that structure, Graetz said. But their earnings could be boosted by blocker corporations that promote investments by nonprofits, he said.
Romney's taxpaying strategy may become clearer when he makes his 2012 tax returns available in April as he has promised.
Congress has tried to make it harder for investors to defer tax payments by broadening requirements that U.S. investors in foreign-based funds pay taxes as they earn profits. But aggressive tax planners can still find ways to get around the rules, experts said.
"You have to look at each investment and its structure before you can pass judgment," Steuerle said.
Benefits to deferring tax payments include the ability to reinvest the deferred taxes, earning higher returns before bringing the money into the U.S. A wealthy investor who has no immediate need for the money would be able to keep the investment offshore indefinitely, never paying U.S. taxes on it.
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