Carried interest tax proposal could hit a quarter of buyouts

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House Republicans’ chief tax writer has investment managers in his crosshairs.

Representative Kevin Brady, the House Ways and Means Committee chairman, moved this week to include a provision in his party’s tax bill that would raise the bar on which profits are taxed preferentially. If Brady gets his way, deal profits shared with investment managers would be treated as long-term capital gains—and hence taxed at a lower rate than ordinary income or short-term gains—only if they’re earned on investments held for at least three years, rather than one year now.

Exceeding a one-year hold period is the norm in private equity: More than 96 percent of U.S. deals since 2000 have done it, according to PitchBook Data Inc., a Seattle-based researcher.

Profits on deals that last one to three years, however, would lose their preferential tax status if the bill’s current version becomes law. Since 2000, that would have affected 24.3 percent of private equity deals in the U.S., PitchBook said.

For the majority of private equity dealmakers, investment profits—known as carried interest, or carry—is the holy grail of compensation. “Live on management fees, live for carry,” industry wisdom holds. Last year, KKR & Co.’s Henry Kravis and George Roberts took home $63 million apiece in carried interest. Blackstone Group LP’s Steve Schwarzman and Jon Gray collectively got $100 million.

While lawmakers are eyeing additional tax revenue with the new proposal, the private equity industry has already been shifting toward holding investments for longer. The average hold period of global private equity deals involving a U.S.-based firm increased every year in the decade through 2016, according to London-based researcher Preqin Ltd. The average was about 5.2 years for investments exited last year.

“The political optics of such a move might have a greater impact than the tax effect,” said Frank Steinherr, a partner at law firm McDermott Will & Emery LLP who specializes in private equity deals. “A three-year period would still be a quick flip for most private equity shops, and most would just work around to avoid paying higher tax on exit.”

For some buyout managers, hold periods are set to get even longer. Blackstone and Carlyle Group LP, two of the biggest firms, created private equity pools in recent years that can keep companies for as long as two decades.

Bloomberg News
Tax reform Tax breaks Tax cuts Private equity Kevin Brady