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RenTech Uses "Amazing" Legal Trick To Help Employees Dodge Retirement Taxes

Tyler Durden's picture




 

Jim Simons’ Renaissance Technologies and its internal HFT fund Medallion are no strangers to questions about tax avoidance. Last July, a Senate subcommittee report alleged that Renaissance, with the help of Deutsche Bank (of course) and Barclays, skirted leverage limits and avoided paying ordinary income tax on billions in trading profits by using basket options. Here, from the Senate report, is how the scheme worked:

The basket option contracts examined by the Subcommittee investigation were used by at least 13 hedge funds to conduct over $100 billion in securities trades, most of which were short-term transactions and some of which lasted only seconds. Yet the resulting short-term profits were frequently cast as long-term capital gains subject to a 20% tax rate (previously 15%) rather than the ordinary income tax rate (currently as high as 39%) that would otherwise apply to investors in hedge funds engaged in daily trading. While the banks styled the trading arrangement as an “option” under which profits from short-term trades would be treated as long term capital gains, in essence, the banks loaned the hedge funds money to finance their trading and allowed them to trade for themselves in highly leveraged positions in the banks’ proprietary accounts and reap the resulting profits. The banks offering the “options” benefited from the financing, trading, and other fees charged to the hedge funds initiating the trades. In the end, the trading conducted by the hedge funds using the basket option accounts was virtually indistinguishable from the trading conducted by hedge funds using their own brokerage accounts, and provided no justification for treating the resulting short-term trading profits as long-term capital gains.

 

There you go. And while it sounds (and looks) complicated, it was all, as we explained at the time, motivated by a very simple desire to reclassify short-term capital gains into long-term profits, in the process saving about 25% of the absolute profit from any transaction.

How much did this 17X leveraged, “fictional derivatives” scheme cost taxpayers, you ask? Around $6 billion apparently, and as it turns out, Renaissance wasn’t done coming up with creative and technically legal ways to avoid paying the Treasury because as Bloomberg reports, the firm’s employees will now get to invest their retirement in Medallion (the firm’s internal HFT high-flyer) tax free:

It’s one of the sweetest employee perks in the hedge-fund world: a chance to invest in Medallion, the wildly profitable fund created by market legend James Simons.

 

Now, with deft legal maneuvers and a blessing from Washington, the firm Simons started is giving its employees an even richer opportunity -- a tax-advantaged, fee-free ticket to one of the world’s top-performing hedge funds.

 

In a series of unusual moves, Renaissance Technologies abolished its 401(k) plan and won the government’s permission to put pieces of Medallion fund inside Roth IRAs. That means no taxes -- ever -- on the future earnings of a fund that averaged a 71.8 percent annual return, before fees, from 1994 through mid-2014.

How is this possible? Well, the first step was to eliminate 401(k)s and move everyone into IRAs, which Renaissance did in 2010. Next, Renaissance’s lawyers told the Labor Department that in their view, it wasn’t entirely fair that the firm’s employees were stuck investing their retirement savings in traditional funds offered through the likes of Fidelity because after all, carbon-based portfolio managers have a tough time replicating HFT-like returns. Two years, and a lot of paperwork later, Renaissance was granted a waiver which allowed for the inclusion of Medallion fund in employees’ IRAs. Renaissance has since set up another 401(k) which, thanks to a second government waiver, also includes Medallion. More from Bloomberg:

After questioning that yielded a foot-high stack of public records, the Labor Department granted the exemption in 2012.

 

As of the end of 2013, Renaissance was running an employer IRA plan that attracted $86.6 million in initial investments and had 259 active participants.

 

Assets in the plan jumped 49 percent to $153 million during its first full year of existence in 2013, and almost all of that came because of growth in the funds, rather than new contributions or rollovers. The fee-free version of Medallion returned about 47 percent that year, compared with about 25.5 percent for the fee-paying version.

 

While seeking the IRA exemption, Renaissance also set up a new 401(k). (Such plans permit greater annual contributions than IRAs.)

 

Renaissance then returned to the Labor Department to ask for permission for the new 401(k) to invest in Medallion, too. In November 2014, the Labor Department said yes..

 

For Renaissance employees, the results of the firm’s maneuvers are fee-free, tax-advantaged investments and the prospect of ballooning balances in their Roth IRAs.

For those wondering exactly what all of this means in real money terms, consider this:

From 2001 through 2013, the fund’s worst year was a 21 percent gain, after subtracting fees. Medallion reaped a 98.2 percent gain in 2008, the year the Standard & Poor’s 500 Index lost 38.5 percent.

 

If Medallion repeats that 13-year performance, a $300,000 taxable investment would turn into $4.7 million. A Roth IRA funded with $300,000 would be worth $26.3 million -- and a no-fee version would be even bigger.

So, while America's policemen, firemen, and school teachers are subjected to daily headlines trumpeting billions in underfunded pension liabilities, hedge fund employees (especially those who work for HFTs) are going to do just fine.

Who loses as a result of all of the above? Well frankly, you do...

“This is an issue of fairness, and taxpayers end up paying the price" -- Senator Ron Wyden

 

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Thu, 06/18/2015 - 21:36 | 6212306 AccreditedEYE
AccreditedEYE's picture

And the Fed thinks it was/is most important to keep interest rate policy easy for these folks. Can't go upset the apple cart of easy/fixed profits with low, low taxes to boot. Yeah, keep working 9 to 5 for your measly 50-75k a year you idiots.

Thu, 06/18/2015 - 22:33 | 6212502 Soul Glow
Soul Glow's picture

Working?  Most people living the American dream are slaves to the corporate structure that pimps them out to the banks that steal their wealth.

Thu, 06/18/2015 - 23:40 | 6212690 Urban Roman
Urban Roman's picture

The amazing legal trick is, all the arrows point back INTO that "thing" ... there is no way to ever get your money back OUT.

Thu, 06/18/2015 - 23:49 | 6212718 SafelyGraze
SafelyGraze's picture

try this one weird trick to make your taxes disappear

hugs,
the belly-fat ad writers association 

Fri, 06/19/2015 - 02:31 | 6212955 DJ Happy Ending
DJ Happy Ending's picture

39% tax rate? God damn.

Thu, 06/18/2015 - 22:46 | 6212519 NoDebt
NoDebt's picture

I'm not grasping how taxes have much bearing once you have the money in a qualified account, whether it be an IRA, Roth IRA, 410k or Roth 401K.  Once it's in there, it grows tax free no matter how gains are realized- interest, dividends, cap gains.  Doesn't matter.

If you know you're gonna make a killing in terms of returns the Roth option has HUGE advantages because none of those gains are ever taxable again (even as you withdrawal the money in retirement).  Only the incoming CONTRIBUTIONS are taxable.  Would you pay income taxes on your retirement plan contributions if you KNEW they were going to earn 20% a year or more tax-free thereafter FOREVER?  Everyone would- you would hit break-even in just a year or two and everything gained after that would be gravy.

Them switching from Roth IRAs to a Roth 401k makes sense because the contribution limits are much higher (more money can be put in in).  But once it's in, you're out of the tax world forever.  Short term cap gains, long term cap gains, interest, dividends- makes no difference because none of it's taxable.

Gaining an exemption to include an in-house investment option (even if it is a hedge fund) is unusual, but not unheard of.

Thu, 06/18/2015 - 22:52 | 6212540 RaceToTheBottom
RaceToTheBottom's picture

The Roth was how the Romney made his money, plus if I remember correctly he got his as pre IPO shares to even make the growth higher...

Thu, 06/18/2015 - 22:57 | 6212553 NoDebt
NoDebt's picture

Absolutely correct.  Again, the advantage of a Roth account plus guaranteed-can't-lose massive returns on the money once it's in such a qualified account.  If you value the shares put into your Roth IRA or 401k at $1 a share, you pay taxes on $1/share X number of shares.  If those shares are "magically" worth $40/share when the company is IPO'ed or restructured and sold off, well friend, those massive gains are yours FOREVER, TAX FREE.

At that point the income taxes on what you contributed are INSIGNIFICANT compared to the outsized gains you know are coming your way.

The problem isn't the tax treatment, the problem is fraud and corruption, as it always has been.

 

Fri, 06/19/2015 - 05:23 | 6213088 Arnold
Arnold's picture

Untill you withdraw /take distributions.

 

The rest I agree with.

Fri, 06/19/2015 - 06:39 | 6213144 Urban Redneck
Urban Redneck's picture

You're only half right.  The Romney made his money was by converting another qualifying pension into a Roth IRA.  The contribution limit on Roths is negligible, so one needs a bigger starting pile to convert/contribute... if they want to SuperSize their personal tax free stash.  Look at Renaissance - they converted a 401(k) and the average account balance is now about 2 million.  Even if Renaissance paid their employees less than $200,000 per year, and the employees contributed the maximum $5,000 per year to a Roth, it would take a lifetime, even at the rates of return discused to turn a Roth into a tens of millions.

The Roth is mathematically the least significant part of the return calculation.  The retiree would simply have his tens of millions taxed as ordinary income after years of tax deferral.  

Thu, 06/18/2015 - 22:54 | 6212547 brockhardman
brockhardman's picture

It's one big club.  And you ain't in it.

Thu, 06/18/2015 - 23:12 | 6212590 WillyGroper
WillyGroper's picture

Roth contribution limits are paltry & at one time HNW individuals did not qualify.

Obviously, the rules have been reengineered for the likes of Romney et.al.

Thu, 06/18/2015 - 23:50 | 6212696 NoDebt
NoDebt's picture

If you're going to make 20x on your money, even a modest contribution can add up quick.  Remember this was a "perk" of working for this firm, so it was something even the receptionist and the file clerk could access.

401k "discrimination testing" is fairly easily circumvented with a little planning.  Roth IRA contributions can likewise side-step income limitations without great difficulty (which are already fairly high at $183K/yr. for married couples filing jointly).  Probably already well above the income of most of the "rank and file" at this firm.  

If you could put away $10K that you knew was actually worth $1,000K, you'd do it in an instant.  Which is what Romney et. al. did.

Where the "rub" is in this is, I think, how the FUND treats capital gains INTERNAL TO ITSELF- before it has to report its net returns to investors.  If that number is lower, the returns are, obviously, higher.  But I doubt that's the primary driving factor of the outsized returns here.  

Fri, 06/19/2015 - 02:01 | 6212910 quintago
quintago's picture

Well pilgrim, that's why you self-direct your Roth IRA, and then there is a world of opportunities to skirt the contribution limits through abnormally large gains made by lending money to people at usurious rates. Once your account is big enough, you're off to the races.

Thu, 06/18/2015 - 21:36 | 6212308 doctor10
doctor10's picture

I duuno why this is all so double plus bad. I'm sure any retiree can spend money better than, or at least as well as, Fed.gov

Thu, 06/18/2015 - 21:38 | 6212313 Dindu Nuffins
Dindu Nuffins's picture

Become a Greek using this one weird trick from the internet.

Thu, 06/18/2015 - 21:38 | 6212317 q99x2
q99x2's picture

There aren't hardly any taxpayers left and Yellen, Draghi and  Kuroda print to pay for everything. Nobody has to pay for anything because WWIII will pay off all debts.

Thu, 06/18/2015 - 21:40 | 6212326 Pantalone
Pantalone's picture

Riggers.

Fri, 06/19/2015 - 04:57 | 6213070 Dindu Nuffins
Dindu Nuffins's picture

Racist!

Thu, 06/18/2015 - 21:41 | 6212329 Scooby Dooby Doo
Scooby Dooby Doo's picture

Come on people. Everyone should pay their tax. Be fair and we can have a great government experience.

Thu, 06/18/2015 - 21:45 | 6212346 AccreditedEYE
AccreditedEYE's picture

When Fed provides for zero downside, yeah, it's the least you can fucking do.

Fri, 06/19/2015 - 00:39 | 6212806 TheGreatRecovery
TheGreatRecovery's picture

If you are not represented ON THE FEDERAL RESERVE BOARD, then you are being subjected to taxation without representation.

Thu, 06/18/2015 - 21:41 | 6212333 madbraz
madbraz's picture

 

Another one of those "we are richer than you, we do whatever we want even if it's blatantly corrupt" scheme by Wall Street hedge fund/primary dealer types.

 

They should all wear ball and stripes.

 

 

Thu, 06/18/2015 - 22:07 | 6212417 OldPhart
OldPhart's picture

No, they need high fashion...like piercings.  High velocity, full metal jacket, lead piercings.

Thu, 06/18/2015 - 21:44 | 6212337 madbraz
madbraz's picture

And these folks are the type of end recipient of the NY FED's generosity via reverse repo - a multi billion dollar collateral-leverage generating scheme/fraud.

Thu, 06/18/2015 - 21:51 | 6212369 Soul Glow
Soul Glow's picture

Hedge funds don't need to pay taxes because their health is the health of the State, right Obama?

Thu, 06/18/2015 - 21:51 | 6212370 OC Sure
OC Sure's picture

 

 

The US Treasury with no treasure left to manage. 

Way over 18 trillion in debt vs 6 billion tax avoidance?

The monopoly on counterfeiting is responsible for the decimation of the middle class, not tax avoiders.

Thu, 06/18/2015 - 21:53 | 6212373 ThirdCoastSurfer
ThirdCoastSurfer's picture

In the last 5 years, the federal reserve has dumped about $421.8 billion into the US Treasury (thus reducing the deficit by this amount) from the profits it has made on it's holding of mortgage backed securities (thus denying this amount from the economy at large).

If this amount had instead been distributed into the pension accounts of government employees like police, fireman and teachers it is likely that their retirement would be as secure as RenTec.  

Thu, 06/18/2015 - 21:57 | 6212391 kchrisc
kchrisc's picture

A dollar not paid to government is one less bullet to be used on us or some poor foreigner.

Liberty is a demand. Tyranny is submissive.

Thu, 06/18/2015 - 22:17 | 6212454 AccreditedEYE
AccreditedEYE's picture

Do you have the faintest idea of how badly this guy and his ilk are raping you? Honestly?

Thu, 06/18/2015 - 22:51 | 6212539 Jack D. Ripper
Jack D. Ripper's picture

Do you have the faintest idea of how badly Uncle Sam and his oligarch puppetmasters are raping you? Honestly?

Thu, 06/18/2015 - 22:03 | 6212400 OBRon
OBRon's picture

A flat tax is only one third the battle. Simplify GAAP & make mandatory prison sentences for non- or under-reported income greater than $100k should just about do it. 

Thu, 06/18/2015 - 22:08 | 6212421 silentboom
silentboom's picture

So avoiding taxes is "costing taxpayers"?  No avoiding taxes is the duty of every patriot and sane human.  What costs taxpayers is our apathy and our murderous gaggle of sworn thieves.

Thu, 06/18/2015 - 22:43 | 6212459 One And Only
One And Only's picture

If instead of paying bullshit taxes those employees spent that money at your business it's not such a loss. This is a good thing.

Where the loss to taxpayers come to fruition is in the 78,000 pages of the tax code. Think about how many tax payer dollars went into drafting and enforcing 78,000 pages of tax code that no one really understands to begin with.

Thu, 06/18/2015 - 23:13 | 6212592 Augustus
Augustus's picture

Drafting and enforcing are just the beginning costs.

The army of accountants is employed to supposedly make you have a compliant return.  All non-prouctive economic drag and cost.

Thu, 06/18/2015 - 23:41 | 6212626 One And Only
One And Only's picture

Correct. There is a cost in paying the actual taxes but there is another cost in having to hire people to make sure you're doing it right. The thing is a god damn mess.

Meanwhile I could have taken that money and purchased actual things at your store with money that I earned through my labor. But instead you have to essentially pay people to keep you out of jail making sure your taxes are done right (income taxes being unconstitutional to begin with). It's fucked.

Thu, 06/18/2015 - 22:41 | 6212518 JuliaS
JuliaS's picture

So, it's fraud when they don't share? Also, are they implying that the firm cost taxpayers $6bn as that was the amount they would've paid by didn't, so the treasury would compensate for something like this by charging us $6bn they wouldn't have charged otherwise? And who's exactly running the fraud here?

I'm dual-minded when it comes to these articles. On one hand I'm against HFT, on the other hand each time the tax man gets cheated I can only applaud.

What costs taxpayers money is the actual taxes and the way govt. spends cash on wars, blow and hookers. Someone discovers legal loopholes and uses them to wiggle out of commitment? Well, good for them! I hope they keep their cash off shore.

HFT is here. No way around it. It's computerized rule-based bidding process. It's a system no different than all the computers that are already in charge of our lives. The law defines what it means to win and smart people go straight for the shortcuts.

Each time I hear someone doesn't pay tax, I don't think they should. I think I shouldn't pay either. So there!

Thu, 06/18/2015 - 23:11 | 6212582 NoDebt
NoDebt's picture

This isn't at its core about HFT (that's just how they make the money).  This is about tax law and how those gains are treated.  Nonetheless, your point is well taken. 

Thu, 06/18/2015 - 23:11 | 6212584 atomicwasted
atomicwasted's picture

It didn't "cost taxpayers" a cent.  That's the backwards logic similar to "paying for" tax cuts.

Thu, 06/18/2015 - 23:27 | 6212655 Spectre
Spectre's picture

Rand Paul will fix this criminal shit!

Fri, 06/19/2015 - 00:47 | 6212821 TheGreatRecovery
TheGreatRecovery's picture

Did you ask him?

Fri, 06/19/2015 - 00:21 | 6212777 GRDguy
GRDguy's picture

They are required by law to put in the phrase "Past performance is not a guarantee of future results."  

But nobody reads the fine print.

Fri, 06/19/2015 - 00:53 | 6212808 TheGreatRecovery
TheGreatRecovery's picture

TAXATION WITHOUT REPRESENTATION

(That thought "rang a bell" in my head so loudly that I am going to repeat it.)

If you are not represented ON THE FEDERAL RESERVE BOARD, then you are a victim of taxation without representation.

When the Founding Fathers drew up the Constitution, they gave control of the money (YOUR money) to Congress, and your representation was the fact that your vote decided who would get to be Congressman.  And if you didn't like any of the candidates, you could run for Congressman yourself.

Today, the Federal Reserve Board controls the money, but you DO NOT get to vote for the people at the Federal Reserve Board who control the money.  And, additionally, you CANNOT run for a seat on the Federal Reserve Board yourself.  So you have no representation.

Fri, 06/19/2015 - 01:25 | 6212862 basho
basho's picture

so now they'll lose it all.

lmao

Fri, 06/19/2015 - 02:28 | 6212950 RealityCheque
RealityCheque's picture

Tyler, you forget: all income taxation is theft.

Fri, 06/19/2015 - 03:48 | 6213029 californiagirl
californiagirl's picture

Madoff had a "wildly profitable" fund for decades.

Fri, 06/19/2015 - 04:39 | 6213058 n.d.v.
n.d.v.'s picture

C'mon, fix the article, this is embarrasing.

Summary claims 70% annual returns for 10 years, the quote in the article itself claims 20 years and both claims are obviously full of shit.

Fri, 06/19/2015 - 06:43 | 6213153 Watts_D_Matter
Watts_D_Matter's picture

The article is FLAWED...Any conversion from a qualified plan to ANY ROTH vehicle (Roth 401k or Roth IRA) MUST pay taxes on that conversion.  The author should research Roth conversions prior to publishing the article.  

Fri, 06/19/2015 - 07:15 | 6213195 firstdivision
firstdivision's picture

Guess what firm is responsible or a majority of the markets spoof orders and quote stuffing in global markets?  I'll give you a hint..it starts with an 'R'.

Do NOT follow this link or you will be banned from the site!