Hedge fund giant Renaissance Technologies is in talks to resolve a dispute with the Internal Revenue Service over a tax maneuver that saved its owners billions of dollars.
James Simons, the firm’s billionaire founder, and Robert Mercer, an influential backer of President Donald Trump, are among Renaissance insiders who profited from the maneuver and would bear the cost of a settlement. A resolution may entail “substantial” additional payments from investors in the flagship Medallion fund, the firm said in a December letter seen by Bloomberg.
The case is among the largest ever handled by the IRS, pitting it against some of the nation’s biggest political donors. A bipartisan Senate panel estimated in 2014 that Medallion investors underpaid their taxes by some $6.8 billion over more than a decade by masking short-term gains as long-term returns.
Last month, Renaissance for the first time identified the IRS dispute as a potential risk in its annual registration with the Securities and Exchange Commission. The IRS is seeking billions of dollars in back taxes, penalties and interest.
Although the firm acknowledged the possibility of a settlement in the letter, it said it continues to believe the IRS is wrong. A spokesman for East Setauket, New York-based Renaissance declined to comment. The IRS is prohibited from discussing individual cases.
Back Taxes
Medallion, which is open only to current and former Renaissance employees, has generated returns of about 40 percent after fees for decades by using computers to spot market patterns. It’s distinct from the funds Renaissance makes available to outsiders, such as the Institutional Equities Fund.
Medallion earns most of its money through short-term trading of securities and other assets. Such earnings typically get taxed at the same marginal rate as salary. The tax code rewards longer-term investments with a preferential, lower rate.
The dispute centers on transactions the firm carried out with Barclays Plc and Deutsche Bank AG between 2000 and 2015 that had the effect of transforming short-term trading gains into long-term returns. Rather than own securities directly, Renaissance instructed the banks to buy and sell them within a portfolio of assets. It then bought an option from the banks tied to the portfolio’s performance.
Medallion typically held each option for more than a year, and reported the earnings from them to the IRS as long-term capital gains.
Testifying before a Senate subcommittee in 2014, Renaissance officials said taxes weren’t the primary reason for entering into the options deals and that outside tax lawyers signed off on the arrangement.