When the federal corporate tax rate dropped to 21 percent from 35 percent as part of President Trump’s Tax Cuts and Jobs Act, it got private equity firms thinking: is it worth switching from a partnership structure to a corporation to take advantage of the lower rate? Here’s why they probably won’t:

  • A PE firm structured as a C-corporation would face being taxed twice: at the corporate level of 21 percent, and at distribution, when any dividends paid out to the firm’s owners would be taxed at up to 20 percent and plus be subject to 3.8 percent Medicare tax. The partners of a PE firm filing individually, though, would pay 37 percent.
  • There are also state taxes to consider. These obviously vary between states but could well add to the corporate tax bill. For example, Texas has no corporate income tax but has a tax on gross revenue, while in New York, a PE firm would pay the general business tax of 6.5 percent. Some states, like Arizona, also can impose separate taxes for the right of doing business known as “franchise tax” or “privilege tax.” PE firms structured as partnerships need not pay state income tax since they are pass-through entities and their shareholders are liable for paying tax as individual income.
  • The corporate tax rate may not be low for ever. Republicans took quick action to push tax reform through legislation. Yet everything could hinge on the make-up of lawmakers in the House of Representatives and Senate after the midterm elections in November. Democrats may try to change rates should they control Congress, notes Steven Bortnick, a tax partner at law firm Pepper Hamilton.

I caught up with Blinn Cirella, chief financial officer at mid-market private equity firm Saw Mill Capital, last week. She said her firm had been discussing these implications, including double taxation and whether the corporate tax rate would be permanent. For now, they are “holding steady” as a partnership.

Ares Management based its decision to change to C-corporation on appealing to a broader set of public markets investors, which is not something the majority of firms need worry about. Other listed giants have yet to follow suit.

“Speaking quite generally, it’s not worthwhile to move from a partnership form to a corporate form, but the facts and circumstances of each case should be analyzed,” says David Helprin, a principal at EisnerAmper who provides specialized tax consulting to private equity firms.

It seems the switch to C-corporation doesn’t yet make sense for most firms.

Write to the author: dominic.d@peimedia.com