Carried Interest Taxation

As you might know, Senators Baucus and Grassley introduced S. 1624 last Thursday. This bill has already gained notoriety as the “Blackstone Bill,” because it is clearly aimed at limiting the IPOs of private equity firms, and the timing of its introduction was about one week prior to the pricing of the Blackstone IPO.

Understanding how the bill would affect Blackstone requires an overview of the special rules that apply to “publicly traded partnerships.” The current rules can be summarized as follows:

· General Rule: Partnerships are pass-through entities, and the partners pay tax on the earnings of the partnerships depending on the character of the profits earned by the partnership.

· Exception: Partnerships whose interests are publicly traded are taxable as corporations, which pay a flat 35% Federal income tax regardless of character.

· Exception to Exception (General Rule Applies): Publicly traded partnerships earning predominantly “qualifying income” (interest, dividends, capital gains, rents from real property) are not treated as corporations.

According to Blackstone’s SEC filings, the publicly traded Blackstone anticipates being taxable as a partnership under the exception to the exception described above. Blackstone itself would not be subject to Federal income tax, and purchasers of Blackstone equity in the IPO would be taxable at 15% rates on capital gains and dividend income earned by Blackstone.

Back to the Blackstone Bill. The bill would create an “exception to the exception to the exception,” pursuant to which a publicly-traded partnership providing investment advisory services is taxable as a corporation, regardless of whether the partnership otherwise meets the qualifying income threshold. If enacted, the bill would treat Blackstone (and Fortress, which has already gone public) as a corporation. This change would increase the effective rate on Blackstone’s earnings from 15% to 35%.

A delayed effective date would only implement the new treatment for these entities until 2012. However, any other publicly traded private equity partnership would be subject to the Blackstone Bill beginning in 2007.