[Vision2020] More Tax Tricks, Private Equity Style

[Art Deco]

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September 5, 2012
More Tax Tricks, Private Equity Style

Gawker.com was onto something big <http://gawker.com/5936394> last month
when it raised questions about Mitt Romney’s taxes by putting online
confidential documents from Bain Capital, the private equity firm
co-founded by Mr. Romney.

As The New York Times reported this
week<http://www.nytimes.com/2012/09/02/business/inquiry-on-tax-strategy-adds-to-scrutiny-of-finance-firms.html>,
the attorney general of New York, Eric Schneiderman, has subpoenaed Bain
and other private equity firms for documents that could reveal whether they
have used abusive tax strategies to drastically cut their partners’ tax
bills.

At issue is how private equity partners treat management fees for tax
purposes. Such fees, generally 2 percent of the assets they manage, are
normally considered ordinary income, like salaries. But through various
machinations, several firms routinely re-brand the fees as capital gains
from investing, which are taxed at 15 percent, far lower than the top rate
of 35 percent for ordinary income.

Is that legal? Is it legal in some instances and not in others? Mr.
Schneiderman apparently wants to find out. In the past, the Internal
Revenue Service has said that converting management fees into capital gains
is an area of “possible noncompliance,” but it is unclear whether the
I.R.S. has audited the practice. Some tax experts have
argued<http://dealbook.nytimes.com/author/victor-fleischer/>that the
practice is illegal, while others — including those who advise
private equity firms — say it is not even aggressive. What is clear is that
these tactics come on top of a huge existing loophole that allows private
equity partners to pay the capital gains rate on a share of the profits
earned by the funds, which comprises the bulk of their income and are
separate from their management fees.

The upshot is that private equity partners, the deal makers who have become
multimillionaires through debt-driven buyouts of public companies, pay a
flat rate of 15 percent on all or most of their earnings, compared with top
rates as high as 35 percent for wage and salary earners. If that’s not
illegal, it should be.

The best way to end this problem is to get rid of the special rate for
capital gains. As long as income from investments is taxed at a lower rate
than income from work, there will be no stopping the search for ways, legal
or otherwise, to pay the lower rate.


-- 
Art Deco (Wayne A. Fox)
art.deco.studios at gmail.com
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