The private equity tax game

Just after posting on how Congress was going after private equity’s big honeypot, the other shoe dropped: We have a bill that closes the "loophole" under which Blackstone gets to be passive for purposes of avoiding the double corporate tax. Vic has posted, most recently here.

Fortunately, contrary to first reports, the bill only targets the loophole and not the whole passive activity exception under IRC Section 7704. I say that's fortunate because I think the passive activity exception makes some sense:  it targets the firms that least need to retain earnings, and therefore for which the double corporate tax makes the least sense.  Also, there's little justification for destroying the multi-billion-dollar industry that relies on this exception.  That would be shades of the disaster that happened after Congress lowered the publicly traded partnership tax boom on master limited partnerships in the 1980s.  Nothing like Congress creating its own Enron.

Also, for Blackstone and other offerings currently in the mill, the bill, while it would be effective as of today, only bites income for tax years after 2012. So this is a snazzy bit of maneuvering. Congress would get populist brownie points by going after the guy who’s snarfing $400 stone crabs; don the appearance of fairness with the transition rule; and wave a warning to both passive-activity partnerships and private equity generally that could extract some nice rents.

Ok, I know there are those who will say that Schwarzman doesn’t need anymore money or incentive to do what he does.  But it's worth noting that he has created a significant amount of value.  Moreover, there's little doubt that the Blackstone IPO is legit under current law. Why do I say that? Hint: if you’re going to do tax fraud or anything close, don’t do it in a publicly filed IPO in one of the most notorious deals of the year. So this isn’t about fraudulent tax shelters. At worst, its' about pushing the boundaries in a legitimate transaction.

Some would say that Blackstone's IPO is just costly game-playing. Ok, but what is it, exactly, that Congress is doing here with this nifty little bill?

Comments

[M. Hodak]

I like your characterization of the new compensation disclosure rules as "business porn." Most PE managing partners would be more reluctant to go public under this regime, where they have to undress their personal finances in front of the world. I guess this makes Schwarzman a financial exhibitionist?

Such a conclusion is easily warranted by his conspicuous consumption. But I would bet that it makes the more modest, but equally successful, among his peers a little uncomfortable about the attention being drawn to their success.