Prometheus 6

“It makes sense for three guys in a garage making something,” said Victor Fleischer, an associate professor of law at the University of Illinois who met last month with Congressional aides to discuss his research on the tax advantages of private equity firms. “But when you apply those to a $1 billion investment fund, it doesn’t make that much sense.”

The amount of taxes at stake is huge, based on a rough estimate of the earnings of the biggest private equity firms.

Tax Gap Puts Private Equity Firms on Hot Seat
By JENNY ANDERSON and ANDREW ROSS SORKIN

This week, Goldman Sachs, Wall Street’s most profitable firm, reported that it earned about $3.4 billion for the second quarter. As always, it set aside a big chunk of money — $1.1 billion, or about 32 percent — to pay corporate income taxes on its healthy profits.

Then there’s the Blackstone Group — the first big-name private equity firm to proceed with plans to go public in the United States — whose business is similar in many ways to Goldman’s. In the first quarter, Blackstone, a privately run partnership dominated by Stephen A. Schwarzman, earned about $1.1 billion before taxes. Its tax bill? Just $14 million, or 1.3 percent.

Even after the Blackstone partners pay their share, the total should still come to less than half that of their Wall Street counterparts.

The gap is the latest example of an advantage that has existed for decades but gone largely unnoticed — until now. It has allowed private equity firms, like Blackstone, to operate as partnerships and to pay far lower tax rates than corporations, giving them an advantage that critics say is unfair.

Moreover, their partners generally pay no more than 15 percent in taxes on most of the money they earn from the firm, compared with the top individual rate of 35 percent.

Why has this arcane part of the tax code suddenly become a hot-button political issue, igniting a flurry of closed meetings on Capitol Hill and the introduction of a bill on Thursday aimed at eliminating the disparity?

The answer can be traced to the growing prominence of private equity firms, which are now seeking to tap the public markets at a moment when they are using their vast pools of money to acquire companies from Chrysler to Sallie Mae and take them private.

Along with that has come a mushrooming of publicity over the staggering wealth being accumulated by their partners and by those who operate hedge funds, which accumulate capital to invest on behalf of wealthy individuals and institutions.