Private equity executives won a major concession in a battlewith the Obama administration over plans to raise taxes whenselling stakes in their firms, potentially saving billionaires suchas Stephen Schwarzman and David Rubenstein hundreds of millions ofdollars.

President Barack Obama and Representative Sander Levinseparately signaled this month that proposals to raise taxes oninvestment performance fees, known as carried interest, won't applyto profits earned when buyout fund founders and other executivessell some or all of their holdings in their firms. The presidentand Levin, a Michigan Democrat and the party's top member on theHouse Ways and Means Committee, previously backed legislation thatwould have increased rates for carried interest as well as for theso-called enterprise value.

For founders of private equity firms, hundreds of millions ofdollars are riding on how enterprise value is taxed. The biggestfirms have leaders who are aging and are seeking to sell throughinitial public offerings or secondary sales. Others have privatelysold stakes to investors such as public pension funds.

Rubenstein, co-chief executive officer of Carlyle Group, hassaid one of the reasons he is taking his private equity firm publicis to “liquefy” his stake. Blackstone Group LP co-foundersSchwarzman and Peter G. Peterson earned $684 million and $1.92billion, respectively, when they sold stakes as part of the 2007offering. The two took advantage of rules that allow corporationsto write down the value of goodwill to offset taxes they paid onthe gains.

The industry has labeled the increase in the enterprise valuerate as unfair because it singles out private equity managers, andhas used the issue to lobby against proposals to raise its taxes.Excluding enterprise value could make it easier for Congress toboost tax rates for carried interest, said Steve Rosenthal, aWashington-based tax lawyer and fellow at the Urban-Brookings TaxPolicy Center.

“Adding an enterprise value provision might be the concessionnecessary for all sides to declare victory,” Rosenthal said.

Industry executives and their lobbyists have been fightinghigher taxes on carried interest since 2007 and began emphasizingthe enterprise value issue since Congress almost passed an earlierversion of Levin's bill in 2010.

The chances of advancing the proposal in Congress this year areslim because it faces opposition from Republicans who control theHouse of Representatives. The enterprise value debate was one ofthe issues that stalled the carried interest measure in 2010,Rosenthal said.

Ordinary Income

Under current law, buyout fund managers pay different tax rateson different types of income. They pay ordinary income rates of asmuch as 35 percent on asset-management fees. They pay capital gainsrates of 15 percent on carried interest or profits-basedcompensation.

Levin and Obama contend that carried interest should be taxedlike ordinary income, because it is payment for services ratherthan a return of capital. They haven't gotten the proposal throughCongress, even when Democrats controlled the House ofRepresentatives, the Senate and the White House.

The administration's fiscal 2013 budget plan and Levin's latestbill include language that says owners of private equity firmsshould be treated the same as other taxpayers who start and latersell stakes in their business. Earlier versions of the planssingled out investment managers, subjecting them to a regularincome tax rate on profits from stake sales while taxpayers whosold other kinds of businesses could still pay the more favorablecapital gains rate.

Levin has said the feature would provide a backstop shouldprivate equity owners try to skirt higher taxes by selling stakesin their firms.

“While the legislation seeks to tax all income earned formanaging other people's money at the same ordinary tax rates paidby all other Americans, it also aims to treat investment managersin a manner consistent with other taxpayers who start andeventually sell a business,” Levin said in a statement.

The administration “remains committed” to working with Congresson the enterprise value issue, the Treasury Department wrote in itsexplanation of revenue proposals that was released Feb. 13. Thegoal should be “more consistent treatment with the sales of othertypes of businesses.”

The industry's main advocacy group said the new developmentsdon't go far enough.

Multiple Attempts

“There have been multiple attempts to address the enterprisevalue provision within a series of carried interest tax increaseproposals,” Steve Judge, president of the Washington-based PrivateEquity Growth Capital Council, said in a statement. “To date nolegislation has been introduced that effectively eliminates apunitive tax increase singling out only private equity, venturecapital and real estate partnerships.”

Levin has been trying to increase taxes on buyout firms' carriedinterest since 2007. Since then, the president has included similarlanguage in his jobs plan as well as his budget and theadministration has repeatedly used it as part of an argument forwhat it calls tax fairness.

Carried interest's tax treatment has drawn more attentionbecause of Republican presidential candidate Mitt Romney's formercareer as a buyout executive. Romney co-founded private equity firmBain Capital LLC in 1984, and even after retiring from theBoston-based firm in 1999, he still receives carried interest fromvarious Bain funds as part of an exit package. The carried interesttax breaks helped drive his 2010 effective tax rate to below 14percent.

In a Feb. 22 conference call with reporters, Romney economicadviser Glenn Hubbard said as part of a tax overhaul if Romney iselected president, Romney would ask his Treasury secretary to“reconsider and study” the issue.

Jay Carney, the White House spokesman, said Feb. 22 that thecurrent carried interest rule is “bad policy” that must bechanged.

“It's simply not equitable if a hedge fund manager or a privateequity executive pays tax on his or her income at a rate of 15percent when average folks are paying much more,” he said.

The industry's advocacy group, backed by firms includingBlackstone, Carlyle and KKR & Co., called the potential taxincrease “discriminatory and inequitable” because it would targetprivate equity specifically and not other kinds of partnerships.The firms have backed a multimillion-dollar lobbying effort to killthe increases, with Blackstone alone spending $5 million in 2011petitioning Congress on issues including the tax treatment ofcarried interest.

The Obama administration added the language on the sale ofbusinesses in its fiscal 2013 budget proposal because it thinks itis possible to enact carried interest legislation, said a Treasuryofficial speaking on condition of anonymity to discuss theadministration's rationale. The change, the official said, signalsthe administration's willingness to work out the issue.

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