Executives of hedge fund manager Renaissance Technologies will pay as much as $6.8 billion in back taxes, interest and penalties in a settlement with the IRS.
The IRS disputed Renaissance's tax treatment of basket options between 2005 through 2015 within the firm's $15 billion Medallion Fund, which has few external investors.
Basket options were used by hedge funds to convert short-term capital gains to long-term gains until July 2015 when the IRS ended their use.
The basket options gave Medallion portfolio managers "the ability to receive the value of appreciation in certain portfolios, but protected Medallion against declines in excess of the premiums it paid on the options," said CEO Peter F. Brown in a letter sent to clients on Sept. 2 that was obtained by Pensions & Investments.
"At its core," Mr. Brown said, the dispute between Renaissance and the IRS came down to "whether the options should be respected as separate instruments for tax purposes or, as the IRS contended, disregarded so as to treat the Medallion entities that held the options as if they actually held the individual securities in the options portfolios."
After several years of negotiation with the IRS, during which Mr. Brown said in the letter that "we vigorously advocated the correctness of Medallion's tax reporting," the firm's board of directors decided that resolving the firm's tax liability would best serve its investors.
As part of the overall IRS settlement, James H. Simons, Renaissance's founder and the chairman of the board of directors during the period in question, also made an additional payment of $670 million to the IRS, Mr. Brown said.
Investors in Renaissance's other hedge funds are not impacted by the IRS agreement.
A company spokesman could not be reached for comment.
Renaissance currently manages a total of $55 billion in hedge funds.
