While the debate over carried interest's taxes is too esoteric and for many to follow, this tax story is pretty simple. According to the New York Times, Apollo has NOT paid ANY taxes on $133 million in fees by reinvesting the fees back into their funds. At the same time, the firm has the audacity to claim this money as income in SEC filings so that investors will see that the firm has substantial fee income.
Victor Fleisher, a professor of law at the University of Colorado, has campaigned to make private equity pay their fair share of taxes. He explained their tax avoidance strategy this way:
The basic scheme is to waive the management fees, which are then used to make a pre-tax investment in the fund. The problem is that under current law, the receipt of the interest in the fund is probably taxable to the managers, and even if it isn't there's a code section that probably re-characterizes the eventual gain as ordinary income. The private equity guys are just counting on the IRS looking the other way."
The chief financial correspondent of the Times, Floyd Norris, lambasted the current practice of private equity billionaires. He wrote, "It is hard for me to see the difference between that and an arrangement under which my employer invested, on my behalf, money that it would otherwise have to pay me for writing this column. Then I would tell the I.R.S. that I owed no taxes until I liquidated the investment and even then would pay only capital gains rates."
He continued, "If I tried that, I could not get away with it. If the law lets those who work in private equity do it, Congress should change the law."
In a follow up phone call, Norris, whose knowledge of accounting issues is so respected that he was asked to serve on the Public Company Accounting Oversight Board after Enron's collapse, told me that if he worked at the I.R.S that he would be seriously looking at this. He acknowledged that one of the tax agency's hesitations might be that the firms have plenty of money for a sustained fight.
He did caution, "We will not know if the IRS actually did something unless they issue a ruling or one of the defendants fights back in tax court.
Feisty New York Attorney General Eric T. Schneiderman, whom American Prospect magazine named "The Man the Banks Fear Most," may force the hand of the IRS. He has recently issued civil subpoenas to Bain, Apollo, Sun Capital, Kohlberg Kravis and other private equity firms to investigate their tax treatment of management income.
Charles Zehren, the imperious spokesman for Apollo Management, confirmed to me the receipt of the subpoenas by Apollo. (Zehren now denies saying yes when I asked him to confirm the subpoenas. I stand by my reporting. Multiple news accounts have confirmed that Apollo have confirmed that Apollo did receive the subpoenas.)
He then said, "We are not supposed to talk about that. Who told you about it?"
When I asked Rebecca Timms, who works in public relations at Seventy Sixers about the investigation, she said, "You had better talk to Michael Preston about this." Michael Preston, director of 76ers public relations never returned my calls or emails.
The New York Attorney General's critics dismiss this as partisan politics because Schneiderman, a Democrat, subpoenaed the records of Bain, Mitt Romney's old firm. Sources close to Schneiderman's office defend the probe.
"This is not about politics. This is all about increasing the tax receipts of New York State during a time of fiscal crisis."
Multiple sources insisted that Schneiderman intends to pursue criminal action against the private equity firms if it is warranted.
One said, "While the office has only issued civil subpoenas at this time and the investigation is in the earlier stages, it looks like the firms devised an elaborate scheme to avoid paying taxes that they are legally obligated to pay. They either treated the management fees as a return of capital in which case they never paid taxes on the money or they received an interest free loan from New York State allowing then to invest the entire pre-tax sum. To be clear, the New York Attorney General would need to a referral from another law enforcement agency, such as the District Attorney's office, to secure a criminal indictment."
Maybe, the Sixers should change their uniform to black and white stripes.
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