Hedge Fund Managers Win at Tax Time

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April 16, 2007 12:04 PM

The custodians at Wall Street hedge fund offices may be paying more in Social Security taxes than the multi-millionaires they work for under a tax law loophole that some public interest groups say threatens to undermine the integrity of the system.

"This is an attitude issue that taxes are for idiots, and the uber-rich guys are above it," said Jack Blum, a Washington, D.C. tax lawyer and U.S. co-chair of the Tax Justice Network, a non-profit group that seeks to identify tax loopholes worldwide. 

According to Blum, many hedge fund managers are taking their yearly earnings, in the hundreds of millions of dollars, as stock profits, instead of salary.  Social Security taxes are not levied against stock profits.

"This means the guy sweeping the floor is paying more in Social Security tax than the manager running the fund," Blum says.  Even worse, Blum says, is that the fund managers dramatically lower the rate at which their income is taxed because stock profits are taxed at a much lower rate that salary.

Salary in the highest tax bracket is taxed at 35 percent, but profits from stocks held long enough to be called "long-term capital gains" are taxed at 15 percent. A hedge fund manager making $100 million in a year would pay $15 million to the government if he is able to take his income as capital gains, not the $35 million he would have to pay if the income was considered salary.

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David Friedland, president of the Hedge Fund Association, said managers do charge a service fee for their involvement in investor transactions, which is taxed at the income tax rate. "If you charge $1 million for the service, that gets taxed at the income tax rate, just as interest or short-term capital gains would."

Blum says such service fees are often paid to corporations established by the fund managers, allowing them to avoid taking any actual salary.

The practice is exacerbating the government's debt, said Blum, who says without new laws, "the whole tax system goes down the drain."