Fund chiefs were caught unawares by a tax clause within a jobs bill
(Corrects Silver Lake name in the second paragraph.)
For David Rubenstein, the founder of private equity firm Carlyle Group, the prospect of losing a three-year fight over legislation that would force him to pay higher income taxes was bad enough. Then, in late May, he discovered a clause in the same bill that would more than double the taxes he would owe if he sold his stake in the firm or took it public.
Rubenstein became one of several high-profile private equity executives who personally took to the Capitol's corridors to pursuade lawmakers to remove the clause. Rubenstein visited Senator Max Baucus (D—Mont.), the Finance Committee chairman whose panel oversees all tax legislation. He also got an audience with Senate Majority Leader Harry Reid (D—Nev.). Other private equity chiefs, including Glenn Hutchins, co-founder of private equity firm Silver Lake, and David Bonderman, founding partner of buyout firm TPG, also called on lawmakers.
They argue that the clause, part of a broader jobs bill, is a tax on the value of investment partnerships that no other business owner is required to pay. It is buried in three-year-old legislation meant to raise taxes on so-called carried interest, or the share of profits that some private equity and hedge fund managers receive for successfully investing other people's money. That measure would more than double taxes on those partnership profits, from the currently low capital gains rate of 15 percent to higher ordinary income tax rates, now topping out at 35 percent.
In case financiers are tempted to sell their firms to avoid paying the new tax, lawmakers also imposed the higher levy on the proceeds of any stake sale or share offering. Private equity funds and other investment partnerships say they would be the only U.S. businesses unable to take advantage of lower capital gains levies in a sale. "That is discriminatory and inequitable," says Douglas Lowenstein, president of the Private Equity Council, a Washington trade group.
The provision would make an IPO expensive for Rubenstein and his partners. Carlyle spokesman Christopher Ullman acknowledges that the firm has considered going public for years, and that the economics of doing so would be fundamentally changed if the clause became law. Ullman says no public sale of shares is imminent.
The measure with the tax increases passed the House in May and is stalled in the Senate by lawmakers worried about adding to the deficit. Meanwhile, the lobbying by private equity executives may be having some effect. Senator Evan Bayh (D—Ind.) objects to the proposal's impact on sales of buyout firms and other partnerships. Baucus, so far, is not budging. He says he spent "hours and hours" with fund executives before deciding to adopt the clause, after getting advice from the Joint Committee on Taxation to keep it. Victor Fleischer, a University of Colorado law professor whose research was used by lawmakers to draft the tax provision, agrees that it's "absolutely necessary" to keep investment funds from avoiding the new tax. "Fund managers are going to be treated worse than a restaurant founder, but I'm O.K. with that," he says.
The bottom line: A proposed tax hike would make it costly for partners in private equity firms such as Carlyle Group to sell their shares.