Bloomberg published an article on Saturday, July 12th, reporting that a U.S. Senate panel is scheduling a hearing on July 22 to investigate tax strategies used by Renaissance Technologies LLC, the hedge fund founded by math whiz billionaire Jim Simons.

Jim Simons Renaissance Technologies

The sources quoted by Bloomberg say the Senate hearing will focus on a trading strategy Renaissance Technologies used to convert profits from short-term trading into lower-taxed, long-term capital gains. The strategy involves questionable transactions with banks such as Barclays PLC (ADR) (NYSE:BCS) (LON:BARC) and Deutsche Bank AG (NYSE:DB) (ETR:DBK) and has been under investigation by the Internal Revenue Service for several years.

Statement from Renaissance Technologies

Renaissance Technologies issued a press release on Saturday explaining the that tax treatment under investigation in the Senate “is appropriate under current law.”

“These options provide Renaissance with substantial business benefits regardless of their duration,” read the statement. “The IRS already has been reviewing these option transactions for over five years, and Renaissance has cooperated fully with both reviews.”

IRS argues profits were short-term capital gains

The crux of the legal issue here is whether the purpose of the arrangements Renaissance Technologies made with the banks, in which the fund owned option contracts rather than the underlying financial instruments, was a tax dodge, which would mean that fund investors owe taxes at the higher short-term rate.

With the arrangement with the banks, Renaissance’s Medallion could claim that it just owned that one asset — the option contract — and held it for more than a year, so investors could claim their profits to be long-term investments.

Given that gains from short-term capital gains are taxed at federal tax rates of up to 44.4%, compared with a 23.8% top rate for long-term capital gains, we’re talking about a pretty big difference. The short- and long-term capital gains rates were 35% and 15%, respectively, for some of the years in question.

Bloomberg also spoke to a former Renaissance Technologies employee (who wished to remain anonymous) who said the IRS notified him last year it was challenging the option tax technique, and that he could be liable for $90,000 in unpaid taxes if Renaissance ends up losing the legal challenges. A ruling against Renaissance could also result in a steep tax bill for Jim Simons and his wife Marilyn.