Senior Fellow, Urban Institute. Rosenthal researches, speaks, and writes on a range of Federal income tax issues, with a particular focus on business taxes. He practiced tax law in Washington, D.C. for over 25 years, most recently as a partner at Ropes and Gray. Rosenthal also was a Legislation Counsel with the Joint Committee on Taxation, where he helped draft tax rules for financial institutions, financial products, capital gains, and related areas. He is the former Chair of the Taxation Section of the District of Columbia Bar Association. Rosenthal holds an AB and JD from the University of California at Berkeley and an MPP from Harvard University.
Michael Lewis spotlights high-frequency traders with his new book, Flash Boys. These traders use high-speed computers and fast connections to outrace investors, and other traders, to the market. They now account for more than half of all U.S. stock trades. And the flash boys spend billions to save milliseconds (by, for example, laying expensive fiber-optic cables directly between exchanges in Chicago and New York).
A race that is faster than the blink of an eye is hard to conceive. But many of the strategies are easy to understand—the front-running of trades and the manipulation of orders.
The Securities and Exchange Commission (“SEC”) can, and should, regulate the worst abuses–and its absence is befuddling. But there is another possible solution: Tax high–frequency trades. The French already do it. With some modifications, so could we.
After all, flipping stock in milliseconds enriches only the traders–not the efficiency of our financial markets. And other investors pay a price.
Say, for example, you want to buy 1,000 shares of ABC stock, which you expect to appreciate substantially. You ask your broker for the “bid,” which is the highest price a current buyer is willing to pay, and the “offer,” the lowest price a current seller is willing to accept. Say, the bid is $10 a share and the offer is $10.05 on the consolidated market (a national best bid and offer is consolidated from all the exchanges).
Now, if you direct your broker to buy 1,000 shares at $10.05, you expect your broker to fill your order instantly—at least if the size being offered is 1,000 shares or more. But too often only some, or perhaps none, of your order is filled at that price.
What happened? Well, a high-frequency trader beat your order to the market—and the “offer” moved away from you, to say $10.10.
How did this happen? According to Lewis, the market is rigged. An exchange may pay your broker to route your trades through it. The exchange may then allow a high frequency trader to peek at your order on its way to the broader market. This allows the trader to buy stock ahead of you and other investors. The trader can later sell the stock to you or another investor at a higher price.
There are other problems: A high-frequency trader may offer to sell a small number of shares, say 100 shares, simply to move to the front of the consolidated price queue, to tease information out of other investors. Your order for 1,000 shares is routed first to the high-frequency trader, who will sell the 100 shares to you, and perhaps the remaining 900 shares, if the trader can buy the shares at a lower price. The trader effectively acquires an option to sell 900 shares to you at $10.05 for a short period of time.
A related problem, which I have seen often-but is not described by Lewis, occurs if you try to post a better “bid” at the front of the price queue (for example, to buy 1,000 shares at $10.01), Before your bid is displayed, the high-frequency trader will bid to buy 100 shares at $10.02. Because of the high-frequency trader’s early glimpse of your bid, the trader knows your bid exists, but the other market participants will not see it. And, if you try to move your bid to $10.03, the trader will move his to $10.04 (and, again, conceal your 1,000 share order from other market participants).
The SEC can, and should, prevent advance peeks at trades. But a high-frequency tax also could limit market manipulations.
The French apply a high-frequency tax to traders that (1) use computer algorithms to determine the price, quantity, and timing of their orders (2) use a device to process these orders automatically, and (3) transmit, modify, or cancel their orders within half a second. The French charge .01 percent of the value of stock orders a trader modifies or cancels that exceeds 80 percent of all of the trader’s orders transmitted each day. As a result, a trader pays a tax on orders that are not filled—which increases his cost of placing small information-gathering orders. (The French also collect a separate financial transaction tax on completed orders.)
There are pros and cons to the French high-frequency tax, but some variation may be desirable. A properly-structured high-frequency tax would cap the value of speed—to end the race to spend billions to save milliseconds. It also would charge traders to tease information out of investors. But it should exempt participants who contribute beneficially to the markets–like market makers that are registered with an appropriate national securities exchange.
The IRS determined this week that Bitcoin and other digital currencies should be taxed as property, not currency. This means Bitcoin transactions will be taxed as capital gains, not as ordinary income. But, perhaps surprisingly, the act of spending Bitcoin could trigger capital gains taxes. Thus, the use of virtual currencies as a medium of exchange may be complicated.
Bitcoin is taxable upon receipt, starting with the “miners,” for whom it is earnings. (Bitcoin is issued initially to “miners” who provide computer resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger.) Sellers who receive Bitcoin in exchange for goods or services also owe tax on that income. The value at the time the virtual currency is received determines the amount of tax that is due.
But here is the real surprise: Each time a consumer spends Bitcoin, he’ll have to figure the cost basis of his virtual currency, subtract it from the value of his purchase, and pay tax if there is a gain. But, if there’s a loss, it may not be deductible. Investment and business losses generally are deductible, but personal-use losses are not. And the IRS didn’t say whether Bitcoin losses are investment or personal.
So, how is a purchase taxed? Suppose I acquired a Bitcoin last month for $800, which appreciates in value to $900. If I use the Bitcoin to buy a $900 television, I would have $100 of gain, which is equal to the value of the TV less my $800 basis in the Bitcoin.
If I acquire many Bitcoin at varying prices and spend them on many transactions, my calculations would be much trickier. And the prices of virtual currency are notoriously volatile. I would need to track my basis in each Bitcoin—and determine the value of each when it is spent.
If Bitcoin were a currency, users could make these calculations using the many rules for foreign currency transactions. And a small gain (less than $200) from a transaction is ignored completely as long as the gain is attributable to exchange rate fluctuation and the transaction is personal and not for business or investment. If I purchased my television with Canadian dollars, for example, a small amount of currency gain would not be recognized. At the same time, foreign currency losses from a personal transaction generally would not be deductible.
But the IRS says Bitcoin is not currency. Thus, taxpayers must calculate gain on every disposition. For small transactions, those calculations will be challenging. And the deductibility of losses is unclear.
In the tax reform roadmap he released yesterday, House Ways & Means Committee Chair Dave Camp (R-MI) targeted the trillion dollar private equity industry. Not only did he propose to tax the compensation of private equity managers at ordinary rates rather than lower capital gains rates, he also called the industry out.
The official description of Camp’s plan asserts:
A partnership (e.g., a private equity fund) that is in the business of raising capital, investing in other businesses, developing such businesses, and ultimately selling them, is in the trade or business of selling businesses.
For the tax law to be applied consistently, the profits derived by such an investment partnership and paid to its managing partners through management fees and a profits interest in the partnership (generally referred to as a carried interest), should be treated as ordinary income.
Thus, Camp deemed the share of a fund’s profits allocated to the manager to be ordinary income. He stopped short of defining the remaining profits as ordinary income, presumably to protect the other partners (typically, not-for-profit institutions and foreign investors) and to avoid tricky policy questions.
The consequences of this view go far beyond carried interest. For instance, treating a private equity fund as a business could apply for other purposes of the tax law. One example: tomorrow, the U.S. Supreme Court will review a request that it consider a pension case called Sun Capital Partners v. New England Teamsters & Trucking, a dispute that may also turn on whether private equity firms are, in Camp’s words “in the business of selling businesses.”
Camp’s vision is bold—and Congress (or the IRS) should explore it.
The First Circuit U.S. Court of Appeals ruled yesterday that private equity funds are engaged in a trade or business under the Employee Retirement Income Security Act (ERISA). The court said the case, Sun Capital Partners v. New England Teamsters & Trucking, “presented important issues of first impression.” And the court’s resolution of the trade or business issue now may open the door to much higher taxes for private equity funds and their investors.
In a unanimous decision, the First Circuit rejected the district court’s finding that private equity funds are merely “passive” investors, which is the position that nearly all private equity funds take for tax purposes. Under a typical fund’s partnership agreement, the fund must avoid engaging in a trade or business for Federal income tax purposes.
However, the First Circuit concluded that private equity funds that actively manage the operations of their portfolio companies are engaged in a trade or business. It does not matter whether a fund has employees or offices, or if its management company has the employees and offices. The key is whether the fund’s activities (including those of its management company) exceed those of a typical investor. That extra effort, of course, is the essence of private equity business and is used to justify the huge fees the funds charge their investors.
While the decision in Sun Capital means that private equity funds may be liable for unfunded pension liabilities of their portfolio companies, it potentially has much broader tax implications that are critical for private equity funds and their investors. For tax exempt or foreign investors, income from a private equity fund that is engaged in a trade or business is potentially subject to the unrelated business income tax (UBIT) or withholding taxes, respectively. Moreover the decision buttresses the argument that the income of private equity managers should be taxed at higher ordinary income rates, rather than capital gains rates. For more detail on this argument take a look at Tax Vox blogs here and here.
Now may be a good time for private equity funds, their managers, investors, and advisers to reexamine their tax position.
For years, the battle over carried interest has focused on how to tax the compensation of private equity managers. But a careful reading of the law suggests that all the business profits of these investment firms, not just the pay of their managers, are ordinary income, and should be taxed that way.
Until now, the analysis of this issue has simply accepted the funds’ profits as capital gains. But when researching a newly-published article, “Taxing Private Equity Funds as Corporate Developers,” I discovered that Congress intended capital gains to be defined narrowly so that ordinary profits—those that arise from the everyday operation of a business—would be taxed at regular rates.
Private equity funds earn sizable profits, largely from acquiring companies, improving them, and reselling them (and they now manage much greater amounts of money: $2.5 trillion in 2010, up from $100 billion in 1994). The funds report these profits as capital gains, and allocate a large share to their managers as reward for their services (which is how Mitt Romney achieved 14% effective tax rates). But what if these profits are not capital gains at all? And what if our tax rules have been incorrectly subsidizing the growth of these funds for the last two decades?
Our tax laws generally treat the profits of taxpayers that develop and sell property in the course of a trade or business as ordinary income. For example, real estate developers often take many years to buy, develop and resell property, and they report their profits as ordinary income. So, why should private equity funds that buy, develop and resell companies (or their stock) treat their profits as capital gains?
Some believe that all gains from stock sales are capital. But that is not true: Equity that is held, for example, by a dealer (like a stock exchange floor specialist) is ordinary income. And private equity funds, like dealers, make a profit as middlemen: They both buy stock expecting to resell it at a higher price as remuneration for their intermediation efforts.
Although the public has expressed widespread astonishment at the low tax rates on the income of private equity fund managers, our lawmakers are frozen in response. Six years ago, Congressman Sander Levin (D-MI) first introduced legislation to treat any gains allocated to private equity managers as ordinary income. But his legislation stalled. Instead, Congress has struggled to separate (and tax) only the labor, and not the capital, component of the private equity managers’ returns. But these distinctions are overly complex and the latest versions of carried interest legislation are riddled with exclusions for “enterprise value” and other novel concepts.
But the biggest flaw of this approach is that it misses the point: Business profits should be taxed as ordinary income. And private equity funds are the same as other businesses, in that they deploy capital, labor, and other inputs to make their profits.
The IRS should now focus squarely on all of the business profits of private equity funds, and not just the profits allocated to the managers. And it can write regulations to treat the profits as ordinary income without waiting for Congress to act.
Last week’s draft plan by House Ways & Means Committee Chair Dave Camp (R-MI) to reform the taxation of financial products includes two key changes that would simplify rules, reduce manipulation, minimize compliance burdens, and improve tax administration.
The first would require investors to use the “mark-to-market” method of accounting for all derivatives, other than business hedges. The second would require them to use average basis to calculate gains and losses from the sale of stock or mutual fund shares, and not first-in-first-out (FIFO), specific identification, or any other method.
Camp has proposed a unified approach to the taxation of derivatives: the mark-to-market method of accounting. Derivatives are contracts that are valued by reference to other assets or indices. They include swaps, forward contracts, futures, options, structured notes, security lending, and many other arrangements.
The current taxation of derivatives is complicated and inconsistent. There are different rules for different derivatives, for different uses of the same derivative, and for different taxpayers. As a result, two derivatives that are economically the same may be taxed quite differently. Investors often use these tax differences to manipulate the character, timing, or source of their income to reduce their tax liability.
For tax purposes, Camp would treat each derivative (other than business hedges) as if it were sold at the end of each year, and require any gains or losses to be recognized annually. Returns would be taxed as ordinary income. As a result, the taxation of derivatives would become straightforward—and most opportunities to manipulate income from derivatives would disappear.
Second, Camp would require taxpayers use average basis (for each account separately) to calculate the gains and losses from their actual sales of stock and mutual fund shares. Gains and losses still would be taxed at lower capital rates and would continue to be treated as short- or long-term, depending on how long the investment is held (which is determined on a FIFO basis). Camp would eliminate the many other methods for figuring gains and losses.
Currently, brokers must help taxpayers calculate their gains and losses from the sale of stock and mutual fund shares (for stock and mutual fund shares purchased on or after Jan. 1, 2011 and Jan. 1, 2012, respectively). http://www.urban.org/publications/901497.html
However, brokers must accommodate customer requests for multiple methods to calculate gains and losses. For example, suppose an investor purchased 100 mutual fund shares at $10/share on Feb. 1, 2012, 100 shares for $10.50 on April, 1, 2012, and 100 shares for $11 on June 1, 2012. If the investor sells 100 shares for $12/share on Mar. 1, 2013, she could recognize $200 of gain on a FIFO basis, $150 on an average basis, or $100 on a specific identification basis (if she specified the last lot).
These multiple methods encourage tax planning, undermine the simplicity of basis reporting, and confuse taxpayers. For example, for mutual fund shares, taxpayers must now decide whether to provide standing instructions to determine the order in which their shares should be sold (for example, highest basis first), whether to identify specific lots of shares to be sold at the time of sale, whether to elect average basis for their shares (separately for each of their accounts), and whether to revoke or change their average basis elections.
Camp would eliminate that babel of calculations and allow only average cost basis. This would reduce complexity for brokers, cut costs, and make life simpler for investors. Customers would receive standardized reports with no confusing choices, which relatively few investors pursue (how many of you have responded to the requests by your brokers to make basis elections?). Finally, in a rising stock market, taxes are lower with average cost than FIFO.
Last year, Camp tackled international tax reform. His latest proposal to simplify financial taxes is another big step forward. Next, perhaps Camp could propose streamlining tax-favored retirement plans, where savers confront well over a dozen different vehicles (Roth IRAs, traditional deductible IRAs, 401(k)s, individual 401(k)s, SEPs, etc.). The road toward tax reform will be long, but kudos to Camp for what he has done so far.
Normally, at the end of each year, investors sell stock (and other assets) to recognize losses to offset gains recognized earlier in the year. Sometimes they do it the other way around, harvesting gains that can be offset by earlier losses. But this year is different: many investors are recognizing gains, even if they don’t have losses.
They are doing so to avoid a looming tax hike. Unless things change as part of the fiscal cliff drama, the top rate on capital gains will jump from 15 percent to 25 percent (the 20 percent nominal capital gains rate + 3.8 percent included in the health reform law + 1.2 percent, which is the effective marginal rate created by the limits on itemized deductions for high income taxpayers).
That tax hike will induce many investors to take gains over the next few weeks. A similar phenomenon occurred prior to the increase of capital gain tax rates in 1987.
But investors won’t need to give up their ownership interests for very long. Gains from the sale of stock are not subject to the wash sale rules that disallow losses from the sale of a stock that is repurchased within 30 days. So, investors can sell stock one day to trigger their gains and then buy back the stock the next day, thus maintaining their economic position.
Sophisticated investors can engage in even fancier plays. They can, for example, use derivative contracts like total return swaps to trigger the gains on their stock under the “constructive sale” rules, while continuing to hold their stock. Congress enacted the constructive sale rules largely to prevent sophisticated taxpayers from using derivatives to eliminate their stock risk without paying a tax. However, investors have occasionally turned these rules on their head by entering derivatives to accelerate gains.
Private equity managers may fare even better (they have the best lawyers!). By now, avid readers of Tax Vox understand that private equity managers take some of their earnings as “carried interest” capital gains that are taxable at 15 percent, rather than ordinary earnings that are taxable now at 37.9 percent (35 percent + 2.9 for medicare) and soon may be 44.6 percent (39.6 percent + 3.8 percent +1.2 percent). For almost six years, Congress has threatened to recharacterize these gains as ordinary income (Representative Carl Levin (D-MI) introduced the first bill, H.R. 2834, back in 2007). While Congress still has not enacted carried interest legislation, I expect it will next year.
But private equity managers have been busy during these last six years, looking for ways to keep their earnings taxed at 15 percent. The planning payoff is especially large: the fund managers get the 15 percent rate and avoid a potentially much higher 44.6 percent rate on earnings.
Private equity managers apparently have completed much of their planning already. Presumably, some managers have simply rushed the sale of securities held by their funds. Others have asked their funds to pay them early (with, perhaps, a distribution of some of the funds’ securities).
Such strategies benefit the managers, but the funds’ passive investors may not be so eager to pay them early. So managers simply change the way they hold their carried interests by making a taxable transfer of the carried interests to an affiliate. This benefits the managers and preserves the economic deal with the passive investors.
All of this planning suggests that sophisticated taxpayers are outracing Congress again. Many thought that closing the carried interest loophole would help fill the fiscal can with revenue that our government sorely needs. Unfortunately, the managers’ restructuring of their transactions has punched new holes in the can. And, by the time Congress enacts carried interest legislation, more tax planning will occur, and more potential revenue will leak out. And so it goes. . . .
Following the 2008 financial sector collapse, Europeans have been slowly moving, somewhat in concert, towards new financial transactions taxes. Last week, France jumped the gun: it initiated a package of financial transaction taxes all on its own that includes a novel tax on high frequency stock orders.
The high frequency tax applies to traders that (1) use computer algorithms to determine the price, quantity, and timing of their orders (2) use a device to process these orders automatically, and (3) transmit, modify, or cancel their orders within half a second (the half a second has been set by draft administrative guidance). The high frequency tax is .01% on the amount of stock orders modified or cancelled that exceeds 80% of all orders transmitted in a month (under the draft administrative guidance). In effect, France now may tax orders that are not filled. It has created a “non-transaction” tax.
France’s high frequency tax would effectively limit a variety of “layering” techniques, which high frequency traders sometimes use to manipulate the market. For instance, traders may enter multiple fictitious orders to drive a stock price up or down, and then cancel their orders.
Because the high frequency tax targets activities that may harm markets, but leaves other activities untaxed, the levy is more focused than a conventional financial transactions tax. However, it taxes only some trading activities but not others, such as fat fingers or momentum trading, which might be viewed as harmful. Also, the new high frequency tax applies only to operations in France (conducted through a permanent establishment or a subsidiary), and few high frequency traders operate in France. More thought on the scope and the application of a high frequency tax might be worthwhile.
France also adopted a more conventional financial transactions tax, at a rate of .20%, which is higher than the .10% recommended by the European Commission to the EU (and the .03% proposed by Harkin/DeFazio in the U.S.). However, the French transactions tax is much narrower than other proposed financial transaction taxes: the French tax applies only to stock in large capitalized French companies, and not to bonds or derivatives (other than certain credit default swaps on sovereign debt). France was eager to move a financial transactions tax forward, but not at the price of losing its entire financial sector.
For an earlier blog on financial services taxes and background material from our panel discussion on these taxes, click here.
Sellers of stocks and other assets have always had to calculate their cost basis (generally, what they paid for the investment) in order to figure their taxable capital gains. In the past, this was often a hit-or-miss experience that required lots of tedious research (occasionally with help from brokers) and more than a bit of guesswork. This year, for the first time, Congress required stock brokers to report cost basis to both the IRS and taxpayers. Next year, mutual funds must report. The reporting will apply only to newly-purchased stock, so there will be a long transition to the new system.
The goal is to make things easier for taxpayers and improve compliance (that is, reduce mistakes, deliberate or not).
This is a laudable aim, but the IRS faces a number of challenges to make this initiative work. Here are five, excerpted from a new article I wrote for Tax Notes, Basis Reporting: Lessons Learned and Direction Forward.
- Congress standardized the information that brokers and mutual funds must report. It also required taxpayers to either select a basis method (e.g., first-in-first-out (FIFO), average basis, or identification of the specific securities sold) in advance or accept the default choices made by their brokers or mutual funds. These steps improve the quality and consistency of the information, which in turn will facilitate information matching by the IRS, but they greatly confuse taxpayers, at least in the near term.
- Taxpayers are permitted too many choices to calculate their gains and losses, which greatly complicates reporting. So, for mutual fund shares, taxpayers must now decide whether to provide standing instructions to determine the order in which their shares should be sold (e.g., highest basis first), whether to identify specific lots of shares to be sold at the time of sale, whether to elect average basis for their shares (separately for each of their accounts), and whether to revoke or change their average basis elections. And the mutual funds must capture, maintain, transfer, and report these basis choices.
- By law, taxpayers are responsible for reporting their gains and losses correctly on their tax returns, regardless of the numbers they received from their brokers. So, for example, the IRS expects taxpayers to adjust cost basis to reflect tax rules, such as wash sales, which the brokers might not have reflected. In practice, however, most taxpayers will simply transfer the numbers reported to them by their brokers to their income tax returns, and hope for the best.
- The IRS expects to match the new information reports to taxpayer returns to identify misreporting. Whether the IRS can distinguish taxpayer misreporting from system errors in matching is unclear. However, the mere threat of information matching is likely to improve taxpayer compliance.
- Technology advances, such as information reporting and tax preparation software (like Turbo Tax), shield taxpayers from the tax determination process, which is both helpful and harmful. It’s helpful if taxpayers can save time and effort by using the information provided, but harmful if taxpayers cannot confirm or understand the information they have received.
With all of these problems, is basis reporting worth it? I believe the answer is yes, but the transition will be painful.
(Full disclosure: I advise Wolters Kluwer Financial Services–the publisher of GainsKeeper tax software. The views I express are my own and not those of Wolters Kluwer Financial Services.)
Mitt Romney’s holdings in the Cayman Islands have generated lots of interest in investment funds that are managed from the U.S. but incorporated in foreign jurisdictions. But taxable U.S. investors like Romney don’t get much benefit from such funds. The real winners are U.S. tax-exempt entities, such as charities, pension funds, university endowments, and IRAs, as well as foreign investors. And investment fund managers can benefit too.
Here’s why: When tax-exempt investors make money that is separate from their tax-exempt purpose, they are subject to a special tax, known as the “UBIT” or the unrelated business income tax. A special rule also deems all debt-financed income to be unrelated business income. Because deals put together by private equity firms are often heavily leveraged (as are investments by hedge funds), debt-financed income often is generated.
If a tax-exempt entity were a partner in one of these deals, it would be taxed as if it earned the income that was earned by the partnership and, thus, be subject to the UBIT.
But tax-exempts (including individuals who invest through their IRAs) can avoid this tax by investing in a corporation which, in turn, invests in the partnership (or invests directly in the deal). The tax-exempt’s income from its investment then comes either as dividends or capital gains, neither of which is subject to the UBIT. But there is a problem: If the corporation were based in the U.S., it would have to pay corporate-level tax on the earnings from the partnership, thus lowering returns to the tax-exempt. But, if the corporation located in a tax haven, it would owe no tax (U.S. or foreign) on the earnings.
Similarly, foreign investors could use a corporation to block tainted income from a partnership. Normally, foreign investors would be subject to tax on U.S. income that is effectively connected to a U.S. trade or business. But a foreign investor who received distributions from another foreign corporation or realized gains from the sale of its stock could avoid any direct U.S. tax and would not have to file any U.S. returns.
Setting up as a foreign corporation may also benefit the investment fund managers by allowing them to defer compensation. By now, most readers of Tax Vox know that these managers often are paid for their services with profits of a partnership (“carried interest”). But they can also be compensated with a contractual right to payment from a foreign corporation which, like carried interest, can be based on an investment fund’s performance.
Income from a carried interest often is taxed as capital gains rather than as ordinary income, and thus enjoys a lower rate (15 percent v. 35 percent). But the tax is owed right away. The contractual right is taxed as ordinary income, but generally is deferred until the manager is actually paid. If the investments are throwing off long-term capital gains, the manager may prefer to be paid through carried interest. But if the fund is turning over frequently and thus generating lots of short-term gains (which are taxed at ordinary rates anyway), the manager may prefer a contract payment that is deferred—and taxed later.
These arrangements don’t entirely wipe out every investor’s tax liability. U.S. taxpayers, such as Romney, pay tax on their income regardless of where they earn it, so they can’t avoid U.S. tax by investing in Cayman entities. In addition, although U.S. taxpayers generally are not taxed on income derived through a foreign corporation until the income is distributed as a dividend, U.S. investors often must accrue income currently if the foreign corporation primarily has passive income or assets or U.S. owners.
Of course, investment funds may want to incorporate abroad for non-tax reasons, such as fewer regulations and less disclosures. But tax advantages are a major factor. Despite the headlines, tax-exempt investors, and fund managers, and not U.S. taxable investors often benefit most from these arrangements.