Private equity firms have grown into a massive force on Wall Street, moving around billions of dollars, mostly under the radar.
But now as the Blackstone Group is about to go public -- with an IPO expected to rake in more than $4.14 billion -- new scrutiny is being paid to this secretive world, particularly to the amount of taxes private equity firms pay.
To the surprise of many, private equity funds, including Blackstone, pay taxes at the 15 percent capital gains rate instead of at the 35 percent income tax rate most corporations face.
The issue surfaced on Capitol Hill last week when Sens. Max Baucus, D-Mont., and Chuck Grassley, R-Iowa, introduced legislation that would force publicly traded partnerships to pay taxes at the higher corporate rate.
The difference could mean billions of extra tax dollars for the federal treasury. But changing the rate could also hamper strong economic growth attributed to private equity dumping so much cash into the business world.
Just because the corporate tax rate is 35 percent doesn't mean companies actually pay that much. Just as individual taxpayers do, corporations often find ways to lower their taxes.
To encourage certain public policies, the government gives various tax breaks. For instance, to encourage home ownership, the government allows individuals to write off interest on mortgages. Other deductions are given for each child or dependent.
Companies do similar things to cut tax bills. They'll write off depreciation, capital investments, take advantage of research and development tax credits or keep profits earned in overseas markets in those countries. All of this is legal.
At the end of the day, most companies don't pay anywhere near the 35 percent rate.
For instance, General Electric paid a 9 percent effective tax rate on earnings last year, according to ABC calculations based on data from the Securities and Exchange Commission. Hewlett-Packard paid 13.3 percent, McDonald's, 28.3 percent. Walt Disney the parent company of ABC, paid 30.7 percent and Microsoft, 31 percent.
The capital gains tax rate was reduced as part of President Bush's 2003 tax cuts to encourage people to put money into the stock market.
Blackstone -- and its principals -- have certainly done that, pouring billions into the market and, many say, helping drive the value of stocks higher in the last few years.
Private equity funds are structured as partnerships. Investors give them money that is in turn invested in various companies or projects.
The funds make money two ways. First, they charge investors a fee -- typically 2 percent -- of money placed into the fund. That is treated as normal income subject to the higher tax rates.
But the real money for the management team comes from its cut of any gains on investments. Typically, the funds charge 20 percent on every dollar they earn for investors.
Under the current law, that fee is treated as a capital gains and taxed at the lower rate.
The reasoning is that the money comes from profit on investments, not from profit for corporate actions. The companies that the fund invests have already paid a corporate tax. Forcing a private equity fund to do so would be taxing them twice, many argue.
While the legislation is clearly aimed at Blackstone, the group wouldn't actually be affected by the legislation in its current form.