WASHINGTON, DC - FEBRUARY 03: U.S. President Donald Trump delivers opening remarks at the beginning of a policy forum with business leaders chaired by Blackstone Group CEO Stephen Schwarzman in the State Dining Room at the White House February 3, 2017 in Washington, DC. Leaders from the automotive and manufacturing industries, the financial and retail services and other powerful global businesses were invited to the meeting with Trump, his advisors and family.
But the IRS, its staff hollowed out after years of budget cuts, has thrown up its hands when it comes to policing the politically powerful industry. It is also a dramatic understatement of the true cost. It doesn’t include the ever-changing array of maneuvers — often skating the edge of the law — that private equity firms have devised to help their managers avoid income taxes on the roughly $120 billion the industry pays its executives each year.
The private equity industry, which has a fleet of almost 200 lobbyists and has doled out nearly $600 million in campaign contributions over the last decade, has repeatedly derailed past efforts to increase its tax burden. That slice of future profits is known as “carried interest.” The term dates at least to the Renaissance. Italian ship captains were compensated in part with anThe IRS has long allowed the industry to treat the money it makes from carried interests as capital gains, rather than as ordinary income.
Whenever legislation gathers momentum, the private equity industry — joined by real estate, venture capital and other sectors that rely on partnerships — has pumped up campaign contributions and dispatched top executives to Capitol Hill. One bill after another has died, generally without a vote.One day in 2011, Gregg Polsky, then a professor of tax law at the University of North Carolina, received an out-of-the-blue email. It was from a lawyer for a former private equity executive.
“It’s like laundering your fees into capital gains,” said Polsky, whose paper argued that the IRS could use long-standing provisions of the tax code to crack down on fee waivers. “They put magic words into a document to turn ordinary income into capital gains. They have zero economic substance, and they get away with it.”Polsky began talking with the former private equity executive, whose IRS claim accused three firms of illegally using fee waivers.
That was the case at Bain Capital, whose tactics a whistleblower brought to the attention of the IRS in 2012. That year, Bain’s former head Mitt Romney was the Republican nominee for president. This would be the last time the IRS seriously examined private equity, and it would not amount to much.Early in his first term, President Barack Obama floated the idea of cracking down on carried interest.
The Treasury secretary at the time, Jacob Lew, joined a private equity firm after leaving office. So did his predecessor in the Obama administration, Timothy F. Geithner. Current and former IRS officials said in interviews that such audits generally involved issues like firms’ accounting for travel costs, rather than major reckonings over their taxable profits. The officials said they were unaware of any recent significant audits of private equity firms.For a while, it looked as if there would be an exception to this general rule: the IRS’s reviews of the fee waivers spurred by the whistleblower claims. But it soon became clear that the effort lacked teeth.
“It’s the equivalent of picking someone who was used to conducting an interview in English and tell them to go do it in Spanish,” Gregor said.As a presidential candidate, Trump vowed to “eliminate the carried interest deduction, well-known deduction, and other special-interest loopholes that have been so good for Wall Street investors, and for people like me, but unfair to American workers.”
While White House officials claimed they wanted to close the loophole, congressional Republicans resisted. Instead, they embraced a much milder measure: requiring private equity officials to hold their investments for at least three years before reaping preferential tax treatment on their carried interests. Steven Mnuchin, the Treasury secretary, who had previously run an investment partnership, signed off.
Fleischer, who a decade earlier had raised alarms about carried interest, said the measure “was structured by industry to appear to do something while affecting as few as possible.”