Should I Put My Money in Caribbean Tax Havens Like Mitt Romney Does?

What's so special about the Cayman Islands? What's a tax haven? Can I have one, please? The answers to these questions and more.

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Mitt Romney has millions of dollars spread around at least a dozen investment funds run by Bain Capital out of the Cayman Islands, a notorious tax haven, as ABC News reported on Wednesday. This raises some tricky questions, including but not limited to: Isn't this awfully suspicious? How does a tax haven work? And, should I get one? The short answers are, respectively: No, it's complicated but we'll explain, and probably not.

Is Mitt Romney hiding his money illegally? 

No. Moving your money to an obscure tax-haven sounds suspicious, but as far as anybody knows, Romney's investments are above board. If he was trying to hide his money, he'd be doing a pretty terrible job, considering all this information was discovered through public documents.

Before we get into why some of Romney's money is on vacay in the Caribbean, we should talk about who actually controls his investments. Technically, Romney isn't supposed to have a say in where his fortune goes. To avoid potential conflicts of interest when he became governor of Massachusetts, Romney put his wealth in a "blind trust," which he supposedly has no hand in managing.

Romney doesn't control his own money? So, who does?  

The trust is run by Romney's longtime lawyer, Bradford Malt. Back in 2007, when the issue of Romney's offshore investments first came to light, Malt told the Los Angeles Times that he had invested in a number of foreign funds, including one located in the Caymans. As he put it:

"I don't care whether it's the Cayman's or Mars, if it's organized in the Netherlands Antilles or the Jersey Islands," he said. "That means nothing to me. All I care about is whether it's a good fund or a bad fund. It doesn't affect his taxes." 

Wait, if he's Romney's lawyer, how "blind" is this trust, really?

Good question! After all, Malt even invested $1 million of Romney's money in a fund run by the candidate's own son, Tagg. As ABC has reported, Romney's blind trust probably wouldn't be up to snuff for a federal elected official. His campaign has acknowledged so much. But since it was organized in Massachusetts, he got to meet a lower bar. To the best of anyone's knowledge, though, Romney isn't calling the shots on his investment portfolio.

What is a tax haven for, exactly? And why would Romney need one?

Remember, Romney's Cayman investments are in private equity funds run by his old employer, Bain Capital. So you need to start by asking why Bain Capital wants to be somewhere like the Caymans. 

For a private equity firm like Bain, an offshore tax haven is like a very expensive resort where American money can easily meet foreign money, then mingle. They're appealing for foreigners, who get to profit off American assets while avoiding the IRS entirely. And they're appealing for Americans, who get to pay lower taxes on certain types of investments.  

That's sounds really simple!

Oh lord, no it isn't. If you really want to understand how a tax haven works for an American, stay with me for a few paragraphs.

Some of the biggest investors in the United States are tax-exempt organizations, like college endowments and public pension funds. But when it comes to putting their money with private equity, they have a problem. That's because tax-exempt organizations aren't allowed to use borrowed money to make financial investments, or run a for-profit business on the side. Otherwise, they're subject to a special "unrelated business income tax," which maxes out at 35%.

This is where the Caymans and other tax havens come into play, as Rebecca Wilkins, senior counsel of Citizens for Tax Justice, explained to me. To help pensions and their ilk avoid the unrelated business income tax, firms like Bain set up feeder corporations in the U.S. that exist entirely to funnel money to an offshore fund. The American client invests in the feeder corporation, which then sends their money to the Caymans. The profits come back through the same route. Presto chango, their money is no longer subject to high corporate taxes, since they're not directly buying a company, or taking on debt. This (completely legal) trick is one of the reasons public pension funds are among the largest investors in private equity firms.

Sounds great. I want to invest in a Caribbean tax haven!

You can't. 

Why not?  

Because there's no way you're going to stuff a hundred million dollars inside a tax-free account. As the Wall Street Journal reported yesterday, Mitt Romney keeps between $20.7 million and $101 million in a tax-exempt IRA account. It's pretty unusual for an IRA to grow that large. But part of Romney's is invested in high-return Bain funds. Those private equity profits would ordinarily be subject to unrelated business income taxes. According to the paper, "Tax experts say that might explain why Mr. Romney's IRA includes holdings in Bain entities based in offshore locations," including a Cayman Islands fund worth up to $25 million. Essentially, he could be using the same tricks as a pension to save on his IRS bill. 

So Romney is saving a ton of money this way? 

Possibly. Romney doesn't have to pay annual taxes on his IRA returns. But when he does eventually withdraw the money, he'll have to pay taxes as if it were ordinary income, instead of the low, low 15% capital gains rate he would otherwise owe on investment returns. So he gets to build up his money tax free, but the tax man will eventually get a bite.