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Key trends of 2018: Is it time to convert to C-corp?

One of the biggest talking points of the year was whether to join KKR in switching to C-corp status.

Senior management at US private equity firms hotly debated among themselves in 2018 the notion of converting from a partnership to a C-corporation, in reaction to one of the headline measures of the Tax and Jobs Act of late 2017: the slashing of the corporate tax rate from 35 to 21 percent.

Ares was quick to make the move, declaring in February that it would change its status. KKR followed suit a month later. A C-corp is a corporation that is taxed separately from the company’s owners.

But in the end there was no mass conversion. Lawyers pointed out that the effective tax rate did not look any better in most cases. A private equity firm structured as a C-corp would face being taxed twice: on profits at the rate of 21 percent, and at distribution, when any dividends paid to the firm’s owners would be taxed at up to 20 percent and also be subject to a 3.8 percent Medicare levy. This compares with the total rate of 37 percent for partners of a private equity firm filing individually. Lawyers also pointed out that the corporate tax rate might not remain low forever.

Even Ares and KKR did not cite tax for the conversion, but other factors. Ares chief financial officer Michael McFerran said the move would “simplify our structure, broaden our potential investor base, improve our liquidity and trading volume and provide a more attractive currency for strategic acquisitions.” KKR cited similar reasons.

Private equity firm owners have grumbled over the years that the value of their stocks, and therefore their financial power to make acquisitions, has been limited by their partnership structure, since this bars them from inclusion in the equity indices used by the increasingly important universe of index funds. KKR’s stock soared initially following its announcement, as investors anticipated its inclusion in these indices.