The New York Times, on 7/13/07, cited Lee Sheppard, a tax lawyer, who critiques deals for Tax Notes magazine. Mr. Sheppard noted that the absurdly favorable treatment accorded to Blackstone executives. That is, the Blackstone Group effectively avoided paying taxes on $3.7 Billion, the bulk of what it raised last month from selling shares to the public. Mr. Sheppard said the tax loopholes that Blackstone executive benefits found was a sharp reminder of the disconnect between the tax debate in Congress and how the tax system actually operates at the highest levels of the economy. State differently, very wealthy individuals obtain tax concessions that almost nobody else receives.
Mr. Sheppard pointed out that instead of paying taxes, the Blackstone executives will instead receive an annuity from the government. That is, although the Blackstone executives will initially pay $553 million in taxes, the partners will not only get all $553 million back, and about $200 million more, from the government over the long term.
Mr. Sheppard commented that the debate in Congress about whether most of the compensation that fund managers earn should be taxed at the 35% rate that applies to other highly paid Americans or at the 15% rate for capitals misses the big picture. Mr. Sheppard pointed out that Blackstone executives benefited from a tax maneuver that hinges on its use of good will, an accounting term for the value of intangible assets, like a well-known brand name, that are built up by a company over time. For example, Coca Cola or IBM in addition to their sizable assets benefit from their enormous good will or name recognition. This goodwill, extraordinary name recognition, allows companies to sell prices in quantities and prices not available to generic companies. In essence, the goodwill value is part of the reason a company is worth more than the sum of its physical parts, like buildings and equipment.
In simplest terms, the Blackstone partners paid a15% capital gains on the shares they sold last month in the initial stock offering to outside investors (those shares represented a stake in the Blackstone management, not its funds). Blackstone then arranged to get deductions for itself for the $3.7 billion worth of good-will at a 35% rate. In essence, Blackstone executives paid low taxes (15%) but deducted at a high rate (35%).
Under the current law, individuals who create good will cannot deduct it. However, when good will is sold, the new owners can deduct the goodwill because they claim that the good will is eroding over time. In essence the Blackstone partners sold the good will from their left pocket, paying a 15% capital gains tax, and then received the tax benefits in their right pocket at a 35% rate.
These deductions must be spread out over 15 years. The Blackstone partners are getting 85% of the deductions; the new investors are getting 15%.
If these taxes savings were paid as a lump sum this year, the Blackstone partners would receive about $751 million, which is $198 million more than the taxes the Blackstone partners paid on their $3.7 billion of goodwill.
Other private equity firms and hedge funds that have gone public, or plan to, make use of similar techniques. Several tax lawyers, who were interviewed by the New York Times, agreed in principle with Mr. Sheppard’s analysis of the tax structure’s implications. The accountants asked for anonymity because their firms have restricted them from making public states on these tax dodges. A report issued this week by the Congressional Joint Committee on Taxes indicated that other firms also benefited from the special treatment received by Blackstone.
Originally published in the Sarasota Herald-Tribune
