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Private equity firms probably won’t be hurt by the White House’s plan to close the carried-interest tax loophole, Citi says

MarketWatch logo MarketWatch 4/29/2021 Christine Idzelis
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The White House’s plan to close the carried-interest loophole in current tax law probably won’t harm private equity firms, according to a research note from Citigroup.

The so-called carried interest loophole allows Wall Street firms — like private equity and hedge funds — to pay the lower capital gains rate on their income (15% or 20%), rather than paying ordinary income tax rates (up to 37%).

The buyout industry has long fought to keep the favorable tax treatment on carried interest, or the cut of profits its professionals collect when exiting a successful investment. Private equity giants such as Blackstone Group Inc , KKR & Co. Inc. and Carlyle Group Inc. invest billions of dollars in buyout deals on behalf of institutions including pension funds and university endowments. 

“This is not the first time an administration has focused on adjusting the carried interest capital gains tax rate but moreover, we don’t see this as a material risk,” Citi analysts said in a note published the evening of April 28. “Importantly, the proposal will affect individuals” in the private equity industry rather than alternative investment firms directly, they said.

The Citi Research report showed “buy” ratings for KKR Carlyle and Apollo Global Management Inc. and a “neutral” rating for Blackstone the world’s biggest private equity firm. Shares of KKR, Apollo and Blackstone were up less than 1% in Thursday afternoon trading, while Carlyle was down less than 1%.


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The tax rate on carried interest could rise to around 40%, from 23.8%, according to Citi’s initial read of the White House plan. The current level for carried interest breaks down into a 20% tax on net capital gains plus a 3.8% net investment income tax, according to the note.

Contrast that with a top ordinary income rate of 37%, which the Biden administration has proposed raising to 39.6%, the analysts said. Treating carried interest as ordinary income could also mean a bigger tax burden for some hedge fund managers. 

President Joe Biden is calling on Congress “to close the carried interest loophole so that hedge fund partners will pay ordinary income rates on their income just like every other worker,” the White House said in an April 28 statement on the American Families Plan. “While equalizing tax rates on wages and capital gains will address this disparity, permanently eliminating carried interest is an important structural change that is necessary to ensure that we have a tax code that treats all workers fairly.”

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According to Citi, the “key risk” in potentially closing the carried-interest loophole is whether alternative asset managers would seek “to make their professionals ‘whole’ by increasing compensation to offset the personal tax leakage.” While doing so could “pinch” firms’ fee-related earnings and hurt their stock prices, the Citi analysts said such adjustments to compensation are not likely.

KKR, Blackstone, Apollo and Carlyle did not immediately respond to emails seeking comment on closing the carried-interest loophole.

“We suspect already elevated compensation in the industry – both absolute and relative, with multiple forms of compensation,” the Citi analysts said. Beyond base compensation, private equity professionals may receive a variable bonus, portfolio-related income and equity, they explained.

In Citi’s view, a bigger risk to the industry would entail “undermining” other private equity-related economics such as interest expense deduction or limiting leverage. “While full details are yet to emerge, the initial summary proposal does not seem to include such focus,” the analysts said. 

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