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Geoge Soros May Owe Billions In Taxes

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George Soros knows his way around a hedge fund. The billionaire, who ranks at #29 on Forbes' list of billionaires (#19 in the United States) has an estimated net worth of $24.2 billion - built largely on Soros' success with hedge fund management. That number may be about to get a little bit smaller.

Hedge funds are sophisticated - and varied - investment vehicles that depend largely on pooling investments in order to increase the yield. In that way, they're sort of like mutual funds. But the similarities pretty much stop there.

Unlike mutual funds, hedge funds are not currently regulated by the U.S. Securities and Exchange Commission (SEC) (though there are reporting and other requirements). This means that hedge fund managers can pick and choose from a wider range of securities - and they can do so aggressively. Hedge fund managers engage in a little legal gambling: they mix long and short positions, play with derivatives (like futures and options) and, most commonly, leverage one kind of investment against another. With leveraging, you're investing with borrowed money - or hedging your investments (see where the name comes from?) against each other. It's risky. If you do it right, you can get rich. If you do it right almost all of the time, you can get phenomenally rich. And that's what George Soros has done.

Hedge funds have been around since 1949. Alfred Winslow Jones is generally credited with creating the the first hedge fund (which he called a "hedged fund") with a basic concept: buy stocks with leverage and sell others short. It worked. Jones' fund, started with just $100,000: that company, A.W. Jones, now manages over $1 trillion.

The lure of that kind of substantial return made hedge funds extremely popular. By the early 2000s, hedge funds were considered de rigeur for sophisticated investors willing to take a risk in exchange for potential wealth. As that potential wealth grew, so did the potential tax bill, and managers began looking at other options. The solution? Investing in offshore hedge funds. Hedge fund managers are generally taxed on income in the country where the fund is located making relocating to the usual offshore suspects such as the Caymans, Bermuda and Ireland attractive. Tax was essentially deferred on fees from these funds until it landed in the hands of those in the U.S.

Not everyone was happy with this strategy and in 2008, Congress voted to change it. The change was inserted into the Emergency Economic Stabilization Act of 2008 (Public Law 110-343) - and if that sounds familiar, you're not imagining it. That law was also instrumental in the administration of the Troubled Assets Relief Program, or TARP. The new law essentially banned the deferral of fees and compensation by these offshore hedge funds. President Bush signed the law in 2008 and it was effective beginning in 2009. However, fee income that had previously been deferred wasn't required to be recognized until 2017.

But smart people find ways around legislation and that's what happened here. An exemption (since tightened by IRS) existed for companies subject to tax in another jurisdiction so Soros incorporated a new company in tax-favored Ireland (our favorite offshore whipping boy of late) a week before the law was signed - and he transferred the deferred fees to the new company. Since the company was subject to tax in Ireland, the company paid just $962 in tax in Ireland on $3,851 of net income through 2013 (this from Irish regulatory findings as reported by Bloomberg ). The rest of the 7.2 billion of operating income was allocated to investors.

In 2014, Soros shut the company down and moved those deferred fees to another company in the tax-favored Caymans. (Sensing a pattern here?)

By the time the new company in the Caymans was set up, Soros had reportedly deferred $13.3 billion in fees. If tax on those fees actually does come due in 2017, as it should by statute, Soros' tax bill would hit nearly $7 billion. That's assuming a top marginal rate of 39.6% + that pesky 3.8% net income investment tax (NIIT) + state and local taxes. Of course, that's also assuming all of the deferred fees hit the U.S. at the same time without further reductions.

But who are we kidding? Despite Soros' loud contentions that the rich should pay their "fair" share, it's clear that he has a definite idea of what's fair and it doesn't include paying taxes conventionally. While it's true that no one should pay more in taxes than they have to, it's also clear that Soros has engaged in tax planning strategies to minimize and/or defer tax as long as possible in ways that have long raised eyebrows.

That could happen again. Soros is clearly going to have to pay something. But I suspect we'll see some more musical chairs before all of this finally shakes out in 2017. It's been suggested that Soros might donate some of the funds to his charitable foundations, including his Open Society Foundation - subject to the limits on charitable deductions, of course. His charitable donations to date have totaled more than $7 billion.

There may be other deferral and mitigation options up his sleeve. It's clear that Soros isn't going to be blindsided by the tax bill - and his team of financial and tax advisors are, I'm sure, busily researching and vetting his options.

It's a curious position, however, for the man who told CNN's Zakaria in 2012 that he supported higher taxes on the wealthy, including the so-called "Buffett Rule" named after fellow billionaire Warren Buffett because "if you have better distribution of income, the average American will be better off."

Soros has also joined Buffett in the call for higher federal estate taxes in an effort to redistribute wealth. It feels very do-as-I-say-not-as-I-do.

I should add, of course, that despite the fact that all of this feels very dirty, Soros has not been accused of not playing by the rules. He's just using the rules to his benefit. I think the reason that we feel this way about his strategies isn't so much because it's not allowable (it is) but that Soros publicly - and repeatedly - claims that distributing wealth would make things better for you and me. If that's true, then one has to wonder why he's deferring, rather than distributing, his own wealth.

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