One rule for ordinary Americans, another for American hedge fund managers

Last year 5,400 US citizens gave up their passports. Most of them did it to avoid having to pay US taxes on their worldwide income forever (the US charges its passport holders tax on all their income regardless of how much it is, where it is earned, where it is held, or where they live). Those people will be mildly irritated to read an article in this week’s Wall Street Journal on the matter of offshore income and US taxation.

It turns out that there was an easier way to avoid paying tax. Be a hedge fund manager. Yup, according to the WSJ, hedge fund managers have “for years accumulated offshore gains without paying federal and state taxes”.

America’s Internal Revenue Service (IRS) often allows businesses to let executives defer taking compensation (and hence paying tax) as that means that short-term company profits, and hence corporate tax receipts, are higher.

But as everyone now knows, US companies (unlike most US citizens) do not pay tax on non-US earnings unless the cash is repatriated, so this works very much in the favour of the managers of offshore hedge funds. They get to defer taking their compensation and let it roll up tax free outside the US year after year after year – while also paying no US corporation tax. “They just kept rolling and rolling the money,” Richard Zarin, a partner at Morgan, Lewis & Bockius LLP told the WSJ. It looks like they won’t be rolling it any more.

The loop hole was technically closed in 2008 but with a ten-year lead time for the hedge-fund managers to get used to the idea of writing huge cheques to the IRS (some face personal tax bills of over $100m) – and explore every possible way of not doing so (hello charitable foundation).

So there you have it. For years ordinary Americans have been paying tax on all their income; a special group of the super-rich have not. That this inequality is coming to an end makes sense. That it has lasted so long just doesn’t.