The IRS Challenges a Hedge Fund Tax Trick

James Simons, who became a billionaire when he turned his extraordinary mathematical ability from Cold War code breaking to investing, deployed an unusual strategy at his Renaissance Technologies hedge fund to skirt hundreds of millions of dollars in taxes for himself and other investors, according to people with knowledge of the matter. The Internal Revenue Service is challenging the technique, which it called “particularly aggressive,” without naming the hedge fund in the dispute. It’s demanding more tax payments from investors in Renaissance’s $10 billion Medallion Fund, said the people, who declined to be identified because the matter hasn’t been made public.

Renaissance’s strategy involved buying an instrument called a basket option contract from Barclays and other banks so it could convert profit from Medallion’s rapid trading into long-term capital gains, according to the people. The top federal rate on long-term gains is about half that on short-term gains. IRS lawyers released an 11-page memorandum in 2010 describing the technique and outlining an example, without naming Medallion and Barclays. Jonathan Gasthalter, a spokesman for Renaissance, would say only that “the dispute is ongoing and being handled in the appropriate forum.” Kerrie Cohen, a spokeswoman for Barclays, declined to comment. The IRS also declined to comment, citing confidentiality laws.