It was one of the greatest financial bets of all time. Hedge fund manager John Paulson bet big against subprime mortgages ahead of last decade’s financial crisis, earning billions in profits for his funds. It was a gamble that, in the long run, didn’t pay off.
Along with the $4 billion he earned for himself, he nailed a second record-breaking honor when he was slapped with one of the largest personal tax bills in history.
According to people close to the firm, Paulson used a tax provision available at the time to hedge fund managers. After deferring the bulk of taxes on the profits, Paulson’s personal tax bill came due on April 17th when he was required to pay about a billion dollars. This is on top of $500,000 he paid late the year before.
Only one problem.
The sum of his payment surpasses the maximum amount allowable by the IRS for payment by a single taxpayer with a single check. That amount is $99,999,999.
Like many investment managers, Hedge fund managers profit from fees amounting to a percentage of gains generated for their clients. In the case of Paulson & Co. that percentage is 20%.
For years—decades actually—tax authorities allowed hedge funds to defer receipt of this type of income. The reason the IRS permits this deferment of compensation by executives is that it tends to lower the company’s compensation costs, forcing them to pay higher taxes on profits. This offsets income taxes not paid right away by the employees.
Sounds like a win-win situation, right?
Well, maybe not this time.
In the case of offshore hedge funds that don’t pay offsetting U.S. taxes, such as some of those operated by Paulson, the treasury was not on the winning team.
A tax change mandated by Congress in 2008 gave hedge fund managers like Paulson until April 17, 2018 to pay taxes on money accumulated before the law changed. People close to the firm say Paulson turned to his Credit Opportunities fund, which is one of several he operates.
Word has it this fund held about $3.5 billion in assets late last year. The bulk was represented by Paulson’s own interests. He made an initial tax payment late last year by pulling funds from this account. He pulled another $1 billion from the fund and used it for the money due on April 17th.
Guess who was said to be the largest investor in the fund?
The government wants its money, but paying Paulson’s bill might not be easy. He could wire it if he wanted, but might prefer paying by check if he’ll earn interest on the money until authorities cash the check. If so, he might have to submit multiple payments because the IRS will only accept a payment of less than $100 million.
He could do that, if he can get past the most common problem: fitting such huge numbers onto the appropriate line on a check.
We should all have such problems….
Contact Ewerth & Associates, C.P.A., P.C. today by calling 402-486-3777 or request your free consultation online now. As a thank you for scheduling your consultation, we’ll provide a free tax planning book, The Great Tax Escape.