With sequesters and loopholes the only two words that seem to matter in Washington (the latter more than the former as far as action), we suspect the popularity of the so-called 'Bermuda Triangle' tax dodge may raise more than a few eyebrows. Put simply, hedge fund managers create a Bermuda-based re-insurance entity, their clients (high-net-worth individuals) funnel their hard-earned gains through this offshore entity and back to the US hedge funds - dramatically reducing their personal income taxes. The re-insurers do a minimum of business to create the appearance of legitimacy but are enabling hedge fund investors to avoid paying high-rate income tax on any gains from the funds and growing tax-free while in the fund. Of course this is defended as "good tax management." Funds such as Paulson's, Third Point, Greenlight, and SAC all use this vehicle according to Bloomberg as a handy way to funnel a US hedge fund investment through a tax haven. It truly is good to be king...

Via Bloomberg,

By recycling the funds through Bermuda-based Pacre Ltd., the Paulson executives are positioned to legally exploit a little-known tax loophole, reduce their personal income taxes and delay paying the bill for years.

“These types of reinsurance companies are permitting U.S. taxpayers to defer -- indefinitely -- U.S. tax,” said David S. Miller, a tax lawyer at Cadwalader Wickersham & Taft LLP. For some, he said, it’s “an unjustified benefit.”

A decade after the U.S. Internal Revenue Service threatened to crack down on what it said were abuses by hedge-fund backed reinsurers, more high-profile money managers are setting up shop in tax havens. Paulson, SAC Capital Advisors LP’s Steven A. Cohen and Third Point LLC’s Daniel Loeb have started Bermuda reinsurance companies since 2011, following a similar Cayman Islands venture by Greenlight Capital Inc.’s David Einhorn.

Because reinsurers, which sell coverage to other insurers, manage large pools of capital, they’re a handy way to funnel a U.S. hedge fund investment through a tax haven.

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At a time when the Obama administration and Congressional leaders of both parties are calling for a corporate tax overhaul that includes eliminating some loopholes, the reinsurance tax dodge is gaining popularity among hedge funds.

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By setting up reinsurance companies there, money managers can take advantage of a loophole in IRS rules. Ordinarily, when hedge fund managers invest in their funds, they pay either the 39.6 percent rate for ordinary income or the 20 percent long- term capital gains rate, depending on how frequently securities are traded, plus an extra 3.8 percent health-law surcharge. If they were to move the hedge funds to tax havens, they would incur IRS penalties on earnings from what the agency calls “passive foreign investment companies.”

Here’s the catch: The IRS doesn’t penalize earnings from insurance companies, which it considers to be “active” businesses. As a result, by routing money through a Bermuda reinsurer, which in turn puts its assets back into their own hedge funds, fund managers can defer any taxes until selling the stake. They then pay only the lower capital gains tax rate.

In the meantime, the money grows tax-free, and the savings add up. Investing $100 million in a hedge fund that returns 15 percent annually, and paying the top marginal ordinary income rate on profit, results in a $50 million profit after taxes after five years. If the investment is taxed like a Bermuda reinsurer, the gain is $77 million.

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The IRS said some of the offshore arrangements were shams, either because they weren’t selling enough insurance or because the insurance they reported selling was phony. The IRS “will challenge the claimed tax treatment,” government lawyers wrote.

The IRS has rarely if ever done so. Tax lawyers and insurance executives said they were unaware of any company targeted by the IRS, even in private.

“Nobody’s been challenged, so nobody knows whether it’s ironclad or not,” said Faries, the Bermuda lawyer. The IRS declined to comment.

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Those involved in establishing reinsurers defend the strategy. “Given the world we’re in, it’s just good tax management,”