Private equity executives won a major concession in their battle with the Obama administration over plans to increase their taxes when selling stakes in their firms, potentially saving billionaires such as Stephen Schwarzman and David Rubenstein hundreds of millions of dollars.
President Barack Obama and Representative Sander Levin separately signaled this month that proposals to raise taxes on investment performance fees, known as carried interest, won’t apply to profits earned when buyout fund founders and other executives sell some or all of their holdings in their own firms. The president and Levin, a Michigan Democrat and the party’s ranking member on the House Ways and Means Committee, previously backed legislation that would have increased rates on carried interest as well as the so-called enterprise value.
For founders of private equity firms, hundreds of millions of dollars are riding on how enterprise value is taxed. The biggest firms have leaders who are aging and are seeking to cash out through initial public offerings or secondary sales. Others have privately sold stakes to investors such as public pension funds.
Rubenstein, co-chief executive officer of Carlyle Group, has said one of the reasons he is taking his private equity firm public is to “liquefy” his stake. Blackstone Group LP co- founders Schwarzman and Peter G. Peterson earned $684 million and $1.92 billion, respectively when they sold stakes as part of the 2007 offering. The two took advantage of rules that allow corporations to write down the value of goodwill to offset taxes they paid on the gains.
The industry has labeled the hike in the enterprise value rate as unfair because it singles out private equity managers, and has used the issue to lobby against all proposals to raise its taxes. Excluding enterprise value could make it easier for Congress to boost tax rates on carried interest, said Steve Rosenthal, a Washington-based tax lawyer and fellow at the Urban-Brookings Tax Policy Center.
“Adding an enterprise value provision might be the concession necessary for all sides to declare victory,” said Rosenthal.
Industry executives and their lobbyists have been fighting higher taxes on carried interest since 2007 and began emphasizing the enterprise value issue since Congress almost passed an earlier version of Levin’s bill in 2010.
The chances of advancing the proposal this year are slim since it faces opposition from Republicans who control the House of Representatives. The enterprise value debate was one of the issues that stalled the carried interest proposal in 2010, Rosenthal said.
Under current law, buyout fund managers pay different tax rates on different types of income. They pay ordinary income rates of as much as 35 percent on asset-management fees. They pay capital gains rates of 15 percent on carried interest or profits-based compensation.
Levin and Obama contend that carried interest should be taxed like ordinary income, because it is payment for services rather than a return of capital. They have failed to get the proposal through Congress, even when Democrats controlled the House of Representatives, the Senate and the White House.
The administration’s fiscal 2013 budget and Levin’s newest bill include language that says owners of private equity firms should be treated the same as other taxpayers who start and later sell stakes in their business. Earlier versions of the plans singled out investment managers, subjecting them to a regular income tax rate on profits from stake sales while taxpayers who sold other kinds of businesses could still pay the more favorable capital gains rate.
Levin has said the feature would provide a backstop should private equity owners try to skirt higher taxes by selling stakes in their firms.
“While the legislation seeks to tax all income earned for managing other people’s money at the same ordinary tax rates paid by all other Americans, it also aims to treat investment managers in a manner consistent with other taxpayers who start and eventually sell a business,” Levin said in a statement.
The administration “remains committed” to working with Congress on the enterprise value issue, the Treasury Department wrote in its explanation of revenue proposals that was released Feb. 13. The goal should be “more consistent treatment with the sales of other types of businesses.”
The industry’s main advocacy group said the new developments don’t go far enough.
“There have been multiple attempts to address the enterprise value provision within a series of carried interest tax increase proposals,” Steve Judge, president of the Washington-based Private Equity Growth Capital Council, said in a statement. “To date no legislation has been introduced that effectively eliminates a punitive tax increase singling out only private equity, venture capital and real estate partnerships.”
Levin has been trying to increase taxes on buyout firms’ carried interest since 2007. Since then, the president has included similar language in his jobs plan as well as his budget and the administration has repeatedly used it as part of an argument for what it calls tax fairness.
Carried interest’s tax treatment has drawn more attention because of Republican presidential candidate Mitt Romney’s former career as a buyout executive. Romney co-founded private equity firm Bain Capital LLC in 1984, and even after retiring from the Boston-based firm in 1999, he still receives carried interest from various Bain funds as part of an exit package. The carried interest tax breaks helped drive his 2010 effective tax rate to below 14 percent.
‘Simply Bad Policy’
“We’ve been clear about the carried interest rule and why that is simply bad policy and why it needs to be eliminated,” Jay Carney, the White House spokesman, said Feb. 22. “It’s simply not equitable if a hedge fund manager or a private equity executive pays tax on his or her income at a rate of 15 percent when average folks are paying much more.”
The industry’s advocacy group, backed by firms including Blackstone, Carlyle and KKR & Co., called the tax hikes “discriminatory and inequitable” because they targeted private equity specifically and not other kinds of partnerships. The firms have backed a multimillion-dollar lobbying effort to kill the increases, with Blackstone alone spending $5 million in 2011 petitioning Congress on issues including the tax treatment of carried interest.
The Obama administration added the language on the sale of businesses in its most recent budget proposal because it believes it is possible to enact carried interest legislation, said a Treasury official speaking on condition of anonymity to discuss the administration’s rationale. The change, the official said, signals the administration’s willingness to work out the issue.
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