The Private Equity Tax Battle Rages On

On the eve of Blackstone's planned IPO a proposed private equity tax law could throw a wrench in CEO Stephen Schwarzman's plans. Private equity firms make their money via an asset based fee and a performance fee. This is typically* expressed as "2-and-20": the 2% fee is on all assets under management and is taxed at ordinary income rates up to 35% and the 20% is a cut of the firm's profits and is taxed at the 15% capital gains rate.

Under pressure to combat increased income inequality and increase tax revenue, Federal lawmakers had been tossing around the idea of raising taxes on private equity firms by re-characterizing "carried interest" as ordinary income. It appears that they have curbed that discussion for now.

However, since Fortress and Blackstone would both be publicly traded partnerships, Congress, led by Charles Grassley and Max Baucus (pictured above), could overturn a 20 year old tax law that taxes publicly traded partnerships at 15%. Instead these publicly traded private equity firms would be taxed at corporate rates of up to 35%. This won't effect private equity firms who stay private but it will certainly influence whether or not they choose to go public.

If such a bill were to pass Congress and avoid a presidential veto it would certainly dampen the valuations private equity firms have been receiving and create massive disincentives to going public. The law, were it to pass, would grandfather in Fortress and Blackstone for a period of 5 years.

Fortress Investment Group (FIG) was off 6.5% today on the news and is off nearly 30% since late March. I think investors may be overly pessimistic on FIG because of this bill. FIG's effective tax rate today is already somewhere near 25% and much of their income is not tax-advantaged. If, as I expect, this bill doesn't pass this might be a great time to pick up a few shares of FIG on sale. Heck even if the bill does pass, FIG is safe for 5 years and even with conservative growth projections and higher taxes, buying FIG at $23.50 with a PE of 21.5 is a steal.


* Some firms charge more, some less.

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