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Private Equity Is A Business Subject To The New Book Minimum Tax. Treasury Should Say So


When the Senate added a new corporate minimum tax to the Inflation Reduction Act (IRA), it almost added a clarification that private equity is a business that would be subject to the new tax. But two key Senators blocked the clarification.

Now, as Treasury writes regulations to accompany the new law, it must decide whether private equity is a business. The legal answer is easy: Yes, private equity is a business. But the policy answer is harder: Does Treasury want to potentially apply the minimum tax to thousands of smaller companies that are owned by private equity?

But Treasury also has a solution: It can require private equity firms to consolidate the many smaller companies in their portfolios into one tax return, and collect the new tax from their owners, the private equity funds.

Starting next year, the corporate minimum tax will apply to any corporation with more than $1 billion of book earnings that are reported on financial statements. The new tax also will apply to affiliated corporations with book earnings that aggregate to more than $1 billion. A corporate holding company typically owns these businesses and files a single, consolidated tax return on their behalf.

But partnerships such as private equity funds also own and operate sprawling groups of corporations that combined may have book earnings in excess of $1 billion. And partnerships, unlike corporations, do not file consolidated tax returns. So, the open question is whether Treasury will treat the many corporations a private equity firm owns as affiliated—and subject to the corporate minimum tax. And that question turns on whether a fund is a business or merely a passive investor.

While private equity funds treat themselves as passive investors, Congress tried to explicitly clarify the definition of business to ensure their companies were subject to the new tax. However, Senators Krysten Sinema (D-AZ) and John Thune (R-SD) blocked the effort, leaving current law in place.

But the proposed clarification was unnecessary, since current law establishes that private equity is a business. Private equity funds acquire, develop, and eventually sell the businesses they own. The funds’ operations fit the common definition of a business: They are continuous, regular, and substantial. And their large fees and immense profits reflect the size of their undertakings.

A few years ago, the 1st Circuit Court of Appeals explicitly rejected the funds’ position. It quoted an earlier ruling by the 7th Circuit that: “it seems highly unlikely that a formal for-profit business organization would not qualify as a trade or business under the Groetzinger test [which is the applicable Supreme Court precedent].” For private equity, the 1st Circuit echoed the view that “[i]t is one thing to manage one’s investments in businesses. It is another to manage the businesses in which one invests.”

Given that case law, it’s simply not credible to contend that private equity funds are not businesses.

But, by taking the position they are merely passive investors, private equity funds, their investors, and the companies they own, gain a wide range of tax advantages. Exempting the funds and their companies from the minimum tax would add another. As Lee Sheppard, a leading tax analyst observed, private equity “groups could be competing with publicly traded corporate groups. Private equity funds already have tax advantages as business owners; they don’t need a new one.”

Treasury can, and should, clarify that private equity is a business that is subject to the minimum tax. By doing so, Treasury could treat a private equity fund’s group of portfolio companies like a holding corporation’s group of companies for purposes of the tax.

But subjecting a sprawling group of corporations to the tax could raise administrative and practical challenges. Poorly designed, a tax meant to apply to 150 corporations could hit, potentially, thousands.

However, Congress granted Treasury authority to create a “simplified method” to determine the scope of the new tax. Treasury can address the administrative problems by permitting private equity funds to consolidate their portfolio companies into one—and pay the resulting tax. That election would respect both law and policy. And, if a fund prefers to allow its corporations to be subject to the minimum tax separately, it still could do so.

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