Billionaire Edward Lampert may have found a way to shield himself from millions of dollars in taxes under legislation that would raise levies on profits at private-equity firms.
ESL Partners LP, the Greenwich, Connecticut, hedge fund Lampert started more than 20 years ago, and affiliates distributed about $829 million of stock in Sears Holdings Corp., AutoNation Inc. and AutoZone Inc. to him on June 2, according to regulatory filings. The fund is scheduled to transfer more shares in the retailers to Lampert by the end of July.
By taking direct ownership of the shares, Lampert would be taxed at the capital-gains rate of 15 percent when the stock is sold. That is far less than his fund would be required to pay under the bill, which imposes a formula tied to the ordinary income rate of 39.6 percent as of next year, according to Robert Willens, whose New York-based firm analyzes tax and accounting rules for Wall Street clients. Lampert is ranked 316th on the Forbes list of world’s richest people, with an estimated net worth of $3 billion.
“It’s totally an astute thing to do,” Willens said in a telephone interview. “It doesn’t take a fortune teller to predict that we are going to see a lot of this activity between now and the end of the year.”
While the legislation is aimed at reducing a tax break for buyout firms, Lampert’s hedge fund often holds investments for more than a year, making it eligible for the lower rate applied to private equity under the current law.
Steven Lipin, a spokesman for ESL, declined to comment, and Lampert didn’t return telephone calls and e-mails sent to his office.
According to last week’s filings with the U.S. Securities and Exchange Commission, Lampert signed an agreement that he can only sell “or otherwise dispose of” the Sears, AutoZone and AutoNation shares he received through the distribution on the same terms and at the same time as ESL Partners.
Lampert, 47, may have carried out the distribution for estate-planning purposes, said David Himmelreich, a principal at Hynes, Himmelreich, Glennon & Co., a wealth-management firm in Darien, Connecticut. In January, Lampert disclosed that he had placed Sears, AutoZone and AutoNation shares with a combined market value of $10.3 million in a grantor retained annuity trust, a vehicle that allows people to give large sums to family members under the Internal Revenue Code without paying a gift tax.
He set up ESL Partners in 1989 and holds an undisclosed stake in the fund through its general partner, RBS Partners LP. Lampert is also the chairman of Hoffman Estates, Illinois-based Sears, which he acquired through an $11.9 billion merger with Kmart Holding Corp. in 2005 to form what now ranks as the nation’s largest department-store chain.
The hedge-fund group reported owning stocks with a market value of $12.3 billion as of March 31, with AutoZone, AutoNation and Sears accounting for about $11.4 billion. Holdings included shares of Citigroup Inc., Genworth Financial Inc. and Capital One Financial Corp.
In last week’s SEC filings, Lampert described the transfers as “internal restructuring transactions” that will provide him with “direct ownership” of shares he previously held indirectly through the hedge fund. The distribution simultaneously reduces his ownership in the hedge fund, said Lynn Fowler, a partner at the Atlanta law firm Kilpatrick Stockton LLP who specializes in developing tax-efficient business strategies for corporate clients.
Carried Interest Tax
In January, Lampert’s hedge fund made a similar distribution to him on a smaller scale. In 2004, affiliates of ESL Partners transferred some of their holdings to the hedge fund, while Lampert didn’t personally receive any shares, regulatory filings show.
The legislation approved by the House on May 28 would raise taxes on carried interest, or the share of profit paid to managers who run private-equity, venture-capital and real-estate funds. The House had voted three times in three years to raise the levy, only to see the measure stall in the Senate.
With the legislation now before the Senate, Max Baucus, the Montana Democrat who is chairman of the Finance Committee, today proposed revising the formula to reduce the proposed tax on carried interest to $14.4 billion over 10 years. The Congressional Joint Committee on Taxation previously estimated that the private-equity provision adopted by the House, known as Section 710, would raise about $17.7 billion in revenue during the same period.
“This may not be the sole reason Lampert did what he did, but it’s entirely probable that it is one reason,” said Stanley Blend, chairman of the law firm Oppenheimer, Blend, Harrison & Tate Inc. in San Antonio and the former head of the tax section at the American Bar Association. “I’m sure that trying to beat the effective date of Section 710 entered into his thought pattern.”
Private-equity firms pay tax on carried interest at the long-term capital-gains rate because they usually hold investments in buyout targets for at least a year. Hedge funds, which also take about 20 percent of gains as carried interest, have less to lose under the legislation because their profits tend to come from short-term trading, so they are already taxed at ordinary income rates.
Lampert’s hedge-fund group is different because it holds stakes in publicly traded companies such as AutoZone for years.
AutoNation shares have roughly doubled since ESL Partners and its affiliates reported holding a 23 percent stake in October 2001. Sears has risen fivefold since Lampert filed a Schedule 13D in May 2003 showing that his funds owned 49 percent of Kmart. AutoZone has soared to about $186 a share from $30 since ESL Partners disclosed its stake in June 1999.
According to last week’s SEC filings, ESL Partners distributed 3.79 million Sears shares with a market value of about $299 million to RBS Partners on June 2, which in turn sent 3.72 million of the shares to Lampert and 77,470 to his partner, William Crowley. The partnership and its affiliates distributed about 2.79 million AutoZone shares with a value of almost $520 million and 1.16 million AutoNation shares valued at about $23 million to the two money managers through entities such as RBS Partners, based on June 7 closing prices.
Lampert received stock with a combined market value of about $828.9 million, according to the documents. ESL Partners plans to make a second distribution to Lampert and Crowley after obtaining clearance under federal antitrust rules.
Treatment of Distributions
Under current tax rules, distributions of marketable securities by an investment fund such as ESL Partners to its general partner don’t generate a tax bill, according to Fowler. The general partner can then transfer the Sears, AutoZone and AutoNation stock to its managing members, in this case Lambert and Crowley, who would pay taxes at the capital gains rate if they sold the shares at a profit.
As of Jan. 1, a similar distribution would be taxed as ordinary income under the pending legislation, a step that Congress is taking to prevent private-equity funds from avoiding the higher rate by transferring appreciated securities to individuals, Fowler said.
“Lampert actually gets the best of both worlds,” Fowler said in an interview. “He can maintain the capital-gains treatment and he can also control the timing of when he pays that capital gain.”
The move is “a method of having the carried interest distributed out to Mr. Lampert before the effective date of the new legislation,” said Victor Fleischer, the University of Colorado law professor who wrote the 2006 paper “Two and Twenty: Taxing Partnership Profits in Private Equity Funds.”
Depending on the method ESL Partners used to allocate carried-interest profits, Lampert may have already paid the levies imposed on such gains, limiting the tax-related benefits from the distribution he received, Fleischer said.