There were two weeks left in the Trump administration when the Treasury Department handed down a set of rules governing an obscure corner of the tax code.
Overseen by a senior Treasury official whose previous job involved helping the wealthy avoid taxes, the new regulations represented a major victory for private equity firms. They ensured that executives in the $4.5 trillion industry, whose leaders often measure their yearly pay in eight or nine figures, could avoid paying hundreds of millions in taxes.
The rules were approved on Jan. 5, the day before the riot at the U.S. Capitol. Hardly anyone noticed.
The Trump administration’s farewell gift to the buyout industry was part of a pattern that has spanned Republican and Democratic presidencies and Congresses: Private equity has conquered the American tax system.
one recent estimate, the United States loses $75 billion a year from investors in partnerships failing to report their income accurately — at least some of which would probably be recovered if the I.R.S. conducted more audits. That’s enough to roughly double annual federal spending on education.
It is also a dramatic understatement of the true cost. It doesn’t include the ever-changing array of maneuvers — often skating the edge of the law — that private equity firms have devised to help their managers avoid income taxes on the roughly $120 billion the industry pays its executives each year.
Private equity’s ability to vanquish the I.R.S., Treasury and Congress goes a long way toward explaining the deep inequities in the U.S. tax system. When it comes to bankrolling the federal government, the richest of America’s rich — many of them hailing from the private equity industry — play by an entirely different set of rules than everyone else.
The result is that men like Blackstone Group’s chief executive, Stephen A. Schwarzman, who earned more than $610 million last year, can pay federal taxes at rates similar to the average American.
Lawmakers have periodically tried to force private equity to pay more, and the Biden administration has proposed a series of reforms, including enlarging the I.R.S.’s enforcement budget and closing loopholes. The push for reform gained new momentum after ProPublica’s recent revelation that some of America’s richest men paid little or no federal taxes.
nearly $600 million in campaign contributions over the last decade, has repeatedly derailed past efforts to increase its tax burden.
Taylor Swift’s back music catalog.
The industry makes money in two main ways. Firms typically charge their investors a management fee of 2 percent of their assets. And they keep 20 percent of future profits that their investments generate.
That slice of future profits is known as “carried interest.” The term dates at least to the Renaissance. Italian ship captains were compensated in part with an interest in whatever profits were realized on the cargo they carried.
The I.R.S. has long allowed the industry to treat the money it makes from carried interests as capital gains, rather than as ordinary income.
article highlighting the inequity of the tax treatment. It prompted lawmakers from both parties to try to close the so-called carried interest loophole. The on-again, off-again campaign has continued ever since.
Whenever legislation gathers momentum, the private equity industry — joined by real estate, venture capital and other sectors that rely on partnerships — has pumped up campaign contributions and dispatched top executives to Capitol Hill. One bill after another has died, generally without a vote.
An Unexpected Email
One day in 2011, Gregg Polsky, then a professor of tax law at the University of North Carolina, received an out-of-the-blue email. It was from a lawyer for a former private equity executive. The executive had filed a whistle-blower claim with the I.R.S. alleging that their old firm was using illegal tactics to avoid taxes.
The whistle-blower wanted Mr. Polsky’s advice.
Mr. Polsky had previously served as the I.R.S.’s “professor in residence,” and in that role he had developed an expertise in how private equity firms’ vast profits were taxed. Back in academia, he had published a research paper detailing a little-known but pervasive industry tax-dodging technique.
$89 billion in private equity assets — as being “abusive” and a “thinly disguised way of paying the management company its quarterly paycheck.”
Apollo said in a statement that the company stopped using fee waivers in 2012 and is “not aware of any I.R.S. inquiries involving the firm’s use of fee waivers.”
floated the idea of cracking down on carried interest.
Private equity firms mobilized. Blackstone’s lobbying spending increased by nearly a third that year, to $8.5 million. (Matt Anderson, a Blackstone spokesman, said the company’s senior executives “are among the largest individual taxpayers in the country.” He wouldn’t disclose Mr. Schwarzman’s tax rate but said the firm never used fee waivers.)
Lawmakers got cold feet. The initiative fizzled.
In 2015, the Obama administration took a more modest approach. The Treasury Department issued regulations that barred certain types of especially aggressive fee waivers.
But by spelling that out, the new rules codified the legitimacy of fee waivers in general, which until that point many experts had viewed as abusive on their face.
So did his predecessor in the Obama administration, Timothy F. Geithner.
Inside the I.R.S. — which lost about one-third of its agents and officers from 2008 to 2018 — many viewed private equity’s webs of interlocking partnerships as designed to befuddle auditors and dodge taxes.
One I.R.S. agent complained that “income is pushed down so many tiers, you are never able to find out where the real problems or duplication of deductions exist,” according to a U.S. Government Accountability Office investigation of partnerships in 2014. Another agent said the purpose of large partnerships seemed to be making “it difficult to identify income sources and tax shelters.”
The Times reviewed 10 years of annual reports filed by the five largest publicly traded private equity firms. They contained no trace of the firms ever having to pay the I.R.S. extra money, and they referred to only minor audits that they said were unlikely to affect their finances.
Current and former I.R.S. officials said in interviews that such audits generally involved issues like firms’ accounting for travel costs, rather than major reckonings over their taxable profits. The officials said they were unaware of any recent significant audits of private equity firms.
No Money Owed
For a while, it looked as if there would be an exception to this general rule: the I.R.S.’s reviews of the fee waivers spurred by the whistle-blower claims. But it soon became clear that the effort lacked teeth.
Kat Gregor, a tax lawyer at the law firm Ropes & Gray, said the I.R.S. had challenged fee waivers used by four of her clients, whom she wouldn’t identify. The auditors struck her as untrained in the thicket of tax laws governing partnerships.
“It’s the equivalent of picking someone who was used to conducting an interview in English and tell them to go do it in Spanish,” Ms. Gregor said.
The audits of her clients wrapped up in late 2019. None owed any money.
The Mnuchin Compromise
As a presidential candidate, Mr. Trump vowed to “eliminate the carried interest deduction, well-known deduction, and other special-interest loopholes that have been so good for Wall Street investors, and for people like me, but unfair to American workers.”
wanted to close the loophole, congressional Republicans resisted. Instead, they embraced a much milder measure: requiring private equity officials to hold their investments for at least three years before reaping preferential tax treatment on their carried interests. Steven Mnuchin, the Treasury secretary, who had previously run an investment partnership, signed off.
McKinsey, typically holds investments for more than five years. The measure, part of a $1.5 trillion package of tax cuts, was projected to generate $1 billion in revenue over a decade.
credited Mr. Mnuchin, hailing him as “an all-star.”
Mr. Fleischer, who a decade earlier had raised alarms about carried interest, said the measure “was structured by industry to appear to do something while affecting as few as possible.”
Months later, Mr. Callas joined the law and lobbying firm Steptoe & Johnson. The private equity giant Carlyle is one of his biggest clients.
‘The Government Caved’
It took the Treasury Department more than two years to propose rules spelling out the fine print of the 2017 law. The Treasury’s suggested language was strict. One proposal would have empowered I.R.S. auditors to more closely examine internal transactions that private equity firms might use to get around the law’s three-year holding period.
The industry, so happy with the tepid 2017 law, was up in arms over the tough rules the Treasury’s staff was now proposing. In a letter in October 2020, the American Investment Council, led by Drew Maloney, a former aide to Mr. Mnuchin, noted how private equity had invested in hundreds of companies during the coronavirus pandemic and said the Treasury’s overzealous approach would harm the industry.
The rules were the responsibility of Treasury’s top tax official, David Kautter. He previously was the national tax director at EY, formerly Ernst & Young, when the firm was marketing illegal tax shelters that led to a federal criminal investigation and a $123 million settlement. (Mr. Kautter has denied being involved with selling the shelters but has expressed regret about not speaking up about them.)
On his watch at Treasury, the rules under development began getting softer, including when it came to the three-year holding period.
Monte Jackel, a former I.R.S. attorney who worked on the original version of the proposed regulations.
Mr. Mnuchin, back in the private sector, is starting an investment fund that could benefit from his department’s weaker rules.
A Charmed March
Even during the pandemic, the charmed march of private equity continued.
The top five publicly traded firms reported net profits last year of $8.6 billion. They paid their executives $8.3 billion. In addition to Mr. Schwarzman’s $610 million, the co-founders of KKR each made about $90 million, and Apollo’s Leon Black received $211 million, according to Equilar, an executive compensation consulting firm.
now advising clients on techniques to circumvent the three-year holding period.
The most popular is known as a “carry waiver.” It enables private equity managers to hold their carried interests for less than three years without paying higher tax rates. The technique is complicated, but it involves temporarily moving money into other investment vehicles. That provides the industry with greater flexibility to buy and sell things whenever it wants, without triggering a higher tax rate.
Private equity firms don’t broadcast this. But there are clues. In a recent presentation to a Pennsylvania retirement system by Hellman & Friedman, the California private equity giant included a string of disclaimers in small font. The last one flagged the firm’s use of carry waivers.
The Biden administration is negotiating its tax overhaul agenda with Republicans, who have aired advertisements attacking the proposal to increase the I.R.S.’s budget. The White House is already backing down from some of its most ambitious proposals.
Even if the agency’s budget were significantly expanded, veterans of the I.R.S. doubt it would make much difference when it comes to scrutinizing complex partnerships.
“If the I.R.S. started staffing up now, it would take them at least a decade to catch up,” Mr. Jackel said. “They don’t have enough I.R.S. agents with enough knowledge to know what they are looking at. They areso grossly overmatched it’s not funny.”
Republican lawmakers in nearly a dozen states have tried to shape how racism and slavery can be taught in schools, with some bills explicitly targeting the 1619 Project. This month, Tennessee passed a law to withhold funding from schools that teach critical race theory, following a similar law in Idaho. Similar legislative proposals are underway in Texas, New Hampshire and Louisiana.
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Tuesday’s letter added that the same “anti-democratic thinking” behind the failure to offer Ms. Hannah-Jones tenure was evident in efforts by the state lawmakers to ban the 1619 Project from schools.
“We, the undersigned, believe this country stands at a crucial moment that will define the democratic expression and exchange of ideas for our own and future generations,” the letter said.
The University of North Carolina’s trustees are overseen by the university system’s board of governors, which is appointed by the Republican-controlled legislature. Ms. Hannah-Jones, who earned a master’s degree from the University of North Carolina in 2003, is scheduled to start in July, while continuing to write for The Times Magazine.
A university spokeswoman said university leaders would respond privately to the letter of support. Ms. Hannah-Jones declined to comment.
“That so many distinguished historians have signed this letter is yet further testament to the impact she has had in sparking an important conversation about American history,” Jake Silverstein, the editor in chief of The Times Magazine, said in a statement. He added that Ms. Hannah-Jones’s work was “in the best tradition of New York Times reporters who have deepened our understanding of the world with rigorous journalism that challenges the status quo and forces readers to think critically.”
Previous Knight Chairs at the University of North Carolina were tenured.
“It is not our place to tell U.N.C. or U.N.C./Hussman who they should appoint or give tenure to,” Alberto Ibargüen, the president of Knight Foundation, which funds the positions, said in a statement last week. “It is, however, clear to us that Hannah-Jones is eminently qualified for the appointment, and we would urge the trustees of the University of North Carolina to reconsider their decision within the time frame of our agreement.”
In an email on Sunday to faculty members that was reviewed by The Times, Susan King, the dean of the Hussman School, suggested that the board could reconsider the tenure recommendation at a future meeting. “So that this won’t linger on,” she wrote, “we’ve asked for a date certain by which a decision about a board vote will be made.”
Nikole Hannah-Jones, a Pulitzer Prize-winning writer for The New York Times Magazine, was denied a tenured position at the University of North Carolina, after the university’s board of trustees took the highly unusual step of failing to approve the journalism department’s recommendation.
The decision drew criticism from faculty members on Wednesday, who said that the last two people in the position Ms. Hannah-Jones will hold were granted tenure upon their appointment.
In late April, the university announced that Ms. Hannah-Jones was being appointed to the Knight Chair in Race and Investigative Journalism at U.N.C.’s Hussman School of Journalism and Media. She will start as a professor in July, while continuing to write for The Times Magazine. Instead of tenure, Ms. Hannah-Jones was offered a five-year contract as a professor, with an option for review.
In the April announcement, the dean of the journalism school, Susan King, said: “Now one of the most respected investigative journalists in America will be working with our students on projects that will move their careers forward and ignite critically important conversations.”
MacArthur fellowship in 2017, brought a backlash from conservative groups concerned about her involvement in The Times Magazine’s 1619 Project, which was named for the year that slavery began in the colonies that would become the United States. (Ms. Hannah-Jones won the 2020 Pulitzer Prize for commentary for her introductory essay.)
The 1619 Project ignited acontinuing debate about the legacy of slavery, but has faced criticism from some historians over certain claims, and from conservatives who have labeled it “propaganda.” The Republican-controlled North Carolina Legislature appoints the university system’s Board of Governors, which has significant control over the university’s board of trustees.
The website NC Policy Watch reported on Wednesday that U.N.C.’s board of trustees had declined to approve Ms. Hannah-Jones’s application for tenure. A spokeswoman for the university, Joanne Peters Denny, said in a statement that “details of individual faculty hiring processes are personnel protected information.”
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Ms. Hannah-Jones declined to comment. On Twitter on Wednesday evening, she wrote, “I’ve been staying off of here today, but just know I see you all and I am grateful.”
Nearly 40 faculty members from the journalism school signed an online statement on Wednesday calling for the decision to be reversed, saying the failure to grant tenure to Ms. Hannah-Jones “unfairly moves the goal posts and violates longstanding norms and established processes.” The statement added, “This failure is especially disheartening because it occurred despite the support for Hannah-Jones’s appointment as a full professor with tenure by the Hussman dean, Hussman faculty and university.”
It continued, “Hannah-Jones’s distinguished record of more than 20 years in journalism surpasses expectations for a tenured position as the Knight Chair in Race and Investigative Journalism.”
Alberto Ibargüen, the president of Knight Foundation, said that while the foundation funds the Knight Chair position at U.N.C., it has no role in appointments. The agreement calls for a five-year appointment, with tenure review within that period, he said.
“It is not our place to tell U.N.C. or U.N.C./Hussman who they should appoint or give tenure to,” Mr. Ibargüen said in a statement. “It is, however, clear to us that Hannah-Jones is eminently qualified for the appointment and we would urge the trustees of the University of North Carolina to reconsider their decision within the time frame of our agreement.”
Ms. Hannah-Jones’s editors voiced their support on Wednesday. “Nikole is a remarkable investigative journalist whose work has helped change the national conversation about race,” said Dean Baquet, executive editor of The New York Times.
Jake Silverstein, editor of The Times Magazine, strongly defended her and her work.
“Nikole’s journalism, whether she’s writing about school segregation or American history, has always been bold, unflinching and dedicated to telling uncomfortable truths that some people just don’t want to hear,” Mr. Silverstein said. “It doesn’t always make her popular, but it’s part of why hers is a necessary voice.”