The Sure Bet

It should be well known by now that there are two tiers of taxpayers in this country: 1) Those who pay their fair share and 2) Those who do not. I have featured articles that talk about how many of this nation's wealthiest corporations have figured out strategies to pay little, if any, corporate federal income taxes and some have even figured out how to receive large rebates and refunds.

We also know that the top tax bracket for individuals has been held at 35% which, since 1917, is at the lower end of historical levels. While 35% may still seem high, it is a marginal rate which means it is only applied on what is deemed as taxable income. Because the wealthy legally are able to shield a significant amount of their income through a variety of exemptions and deductions (not functionally available to the poor and many in the middle class), few actually pay at the 35% rate in terms of total income.

But the one aspect of the general tax picture that I bet most people don't know -- I certainly didn't -- concerns hedge fund managers. Sam Pizzigati has posted an article, Hedge Funders Have an Achilles Heel, Pray the Public Stays Ignorant About It, that helps to explain how they are getting away with highway robbery at our expense.

First, he explains what hedge funds are and how they operate.

Hedge funds, in effect, operate as mutual funds for deep-pocket investors — and deep pockets only. The hoi polloi can’t invest in hedge funds, and this closed, private status frees hedge funds from those pesky government regulations that open-to-the-general-public mutual funds have to face.

Hedge fund managers, without regulators looking over their shoulders, can invest the dollars they grab from investors anyway they choose. Actually, “bet” might be a better word choice here. Hedge funds have zilch interest in making investments that create real economic value. Their goal instead: Find and exploit marketplace “inefficiencies” that offer the potential for quick — and enormous — killings.

Hedge fund managers make some of these killings the old-fashioned way, gambling on stocks. Sometimes they bet that particular stocks, or other financial assets, will rise. Sometimes they sell particular stocks “short,” betting they’ll sink.

John Paulson, 2010’s top hedge fund earner, placed his biggest bets last year on gold. Other hedge fund managers are chasing after far more unconventional windfall opportunities — in lawsuits, for instance...

He next explains the manner in which these hedge managers are remunerated.

Hedge fund managers don’t have to win all their bets to hit their personal jackpots. They don’t even have to win any. The reason: Investors pay hedge fund managers fees for the privilege of managing their money, usually 2 percent of the total invested. Hedgie superstars can charge more, 3 percent and up.

These superstars do, of course, have to deliver big returns every so often, to justify those fees, and these big returns provide hedge fund managers an even more lucrative income stream. Hedge fund managers routinely rake off 20 percent of whatever investment profits they generate...

For many, we're not talking about money in the thousands -- we're talking about tens of millions up to billions! And at what rates is this largess taxed? Hold on to your lunch!

And tax time just happens to be when hedge fund managers really clean up. Corporate CEOs face a 35 percent tax rate on all compensation over $373,650 they took home in 2010. Hedge fund honchos, thanks to the infamous “carried interest” tax loophole, only pay a 15 percent tax on the hundreds of millions they pull in from their “performance fees...”

That's right, friends. Hedge fund managers pay a measly 15% on the majority of their "take home pay."

To put this in perspective, let's say you have a family of four and taxable income in your home is $70,000 per year. While a hedge fund manager pays only 15% on the majority of his windfall, you pay 25% on your earnings. If, under the same scenario, your taxable income is $110,000, you pay 28% or almost double what the guy pulling in hundreds of millions pays.

While the bets hedge fund managers place may involve a high degree of risk, when it comes to tax time, there is no risk involved. It's a sure bet that they will get to hold onto the big money they extract from the rest of us!