Audit of Fund Manager Was Muddled Mess

Mina Gerowin was one of the few people inside or outside the financial industry to predict the collapse of the subprime mortgage market in 2008.

As a hedge fund manager with Paulson Europe LLP, she was in a position to make a lot of money for her clients and her employer with that prediction, and did so. Paulson rewarded her accordingly, with a $19 million bonus, which she received early in 2009.

Gerowin, whose legal name is Mina Gerowin Herrmann, and her husband Jeffrey Herrmann were residents of the U.K. while Gerowin worked in Paulson’s London office, and they paid U.K. tax on the bonus and claimed a foreign tax credit for those U.K. taxes on their U.S. return.

And all was good—until the Internal Revenue Service decided that the bonus wasn’t a bonus and that she received it in 2008. And, oh, yes, because she didn’t report the income in 2008, she had a deficiency, and, no, she couldn’t claim a credit or refund for the tax she paid in 2009.

The IRS took the position that Gerowin was a partner in Paulson Europe and received a partnership distribution. This position was supported by the fact that Gerowin signed a deed of adherence and contributed 30,000 pounds ($38,021) to Paulson Europe. It was Gerowin’s understanding that she had to become a member of Paulson Europe so that the entity could avoid certain U.K. employment tax obligations.

Gerowin maintained that she wasn’t really a partner in Paulson Europe, which wasn’t unreasonable because she didn’t receive a Schedule K-1, which reports a partner’s share of profits and losses, from Paulson Europe until after the IRS had begun an audit of the partnership in 2011.

Nevertheless, the IRS determined Gerowin was a partner and concluded the $19 million payment was a partnership distribution that should be included in her 2008 income. Or, according to the agency, she was a partner for purposes of computational adjustments but not with regard to her ability to contest the adjustment.

The IRS wouldn’t let Gerowin or her representatives participate in any substantive way in the telephone closing conference for the Paulson Europe audit. She paid the $7.86 million deficiency for 2008 determined by the IRS and filed a refund claim. The IRS then said she couldn’t claim a refund because she checked the wrong box on the form to challenge the determination. The agency also said she couldn’t carry back the 2009 foreign tax credit to offset the 2008 taxes it maintained she owed.

Gerowin and her husband had to file a lawsuit and endure three years of litigation to get the refund. Judge Charles F. Lettow of the U.S. Court of Claims ultimately ruled in favor of Gerowin on June 12 and awarded her the refund with interest.

Lettow may have been gracious in a 2015 ruling rejecting the IRS’s “wrong box checked” argument when he described the agency’s handling of the matter as “muddled.”