Update, August 8: Senators passed an amendment from Sen. John Thune (R-SD) to remove this $35 billion tax increase from the IRA and replace it with a one-year extension of the $10,000 cap on state and local tax (SALT) deductions. Senators then passed an amendment from Sen. Mark Warner (D-VA) that removed the tax increase, replaced it with a two-year extension of limitations on net operating loss (NOL) deductions, and superseded the Thune amendment.
As Senators look to wrap up votes on a massive tax-and-spending package known as the Inflation Reduction Act (IRA), small and mid-sized businesses who have received private investments to help them grow could be in for a major, unwanted tax surprise if the IRA passes as currently written.
One of the last-minute changes Senate Democrats made to the new corporate alternative minimum tax (or ‘book’ income tax, more from NTUF here) would potentially apply the new 15-percent minimum tax to thousands of small businesses employing millions of people.
The language in the bill seems to treat some small- and mid-sized businesses who have received funding from larger investors, like private equity (PE) firms, as one and the same with those PE firms, meaning that if the PE firm meets the $1 billion threshold for the book minimum tax the smaller business that they own a stake in could also be subject to the tax.
According to reports, the nonpartisan Joint Committee on Taxation (JCT) estimates that this language in the bill alone is responsible for around $35 billion raised by the book minimum tax over the next 10 years. That’s $35 billion that could come out of the coffers of smaller businesses trying to grow.
The Arizona Chamber of Commerce, which worked with centrist Sen. Kyrsten Sinema (D-AZ) on changes to the first version of the IRA, expressed their dismay about the provision, calling it a “bait-and-switch tax hike on the backs of over 18,000 small businesses already getting crushed under the weight of record inflation.”
A bait-and-switch tax hike on the backs of over 18,000 small businesses already getting crushed under the weight of record inflation. @SenatorSinema @SenMarkKelly, please stand up for Arizona businesses and reject this provision. https://t.co/uVf4IbzUrX— Arizona Chamber (@AZChamber) August 7, 2022
Democrats responsible for the provision are pushing back on the criticism, with a spokesperson for Senate Finance Chair Ron Wyden (D-OR) saying that this is instead about “[p]rivate-equity behemoths … trying to avoid paying the minimum tax.”
Finance Chair WYDEN spox @AshleySchapitl: "Private-equity behemoths are trying to avoid paying the minimum tax by calling themselves ‘small businesses.’ ... They are arguing that the companies they own be counted differently than companies owned by other corporations." https://t.co/lS8kM06rBo— Julie Tsirkin (@JulieNBCNews) August 7, 2022
NTU continues to review the full consequences of this provision, but we are deeply concerned about its implications – especially given the early response from small businesses.
PE firms and other private funds routinely make investments in small and mid-sized businesses, sometimes gaining a controlling stake in a business’s operations and then relinquishing that controlling stake in the hopes of both enhancing the company’s value and providing a return on investment for the PE firm.
Or, as the nonpartisan Congressional Research Service (CRS) has written:
“...PEs typically take a controlling interest in an operating business, also known as a portfolio company, and engage in financial and operational activities with the hope of increasing the company’s value. PEs are known for active ownership, longer investment time horizons, and financial leverage through the use of debt, but other PE investment and operational styles also exist.
…PE seeks to find the opportunistic timing to sell the portfolio companies through mergers and acquisitions, initial public offerings, or secondary offerings to other PE firms, or they may seek a partial exit through dividend recapitalization, among other methods.”
The changes to the book minimum tax cited above would appear to apply the book minimum tax to a PE “portfolio company” if the PE firm has book income over $1 billion, even if the portfolio company has book income much lower than that.
PE is not a risk-free endeavor for either the investor or the business receiving investments, but according to the Securities and Exchange Commission (SEC), plays an increasingly large role in the U.S. economy. The number of PE funds grew by 31 percent from the beginning of 2020 to the end of 2021, to a total of nearly 19,000 PE funds by the start of 2022. The gross value of those funds’ assets nearly doubled in that time period, from $3.8 trillion at the beginning of 2020 to $6.4 trillion at the end of 2021.
And PE firms have been exiting businesses at high rates in recent months. According to the market data firm Pitchbook:
“Propelled by an extremely hot IPO market, PE-backed exits have more than recovered from the slowdown in 2020.
…While the number of exits has been impressive, a sharp increase in companies’ valuations at exit has been the key factor behind the boom.”
Pitchbook also reports that the PE exit value in the fourth quarter of 2021 was the highest in at least seven years, driven by the value of corporate acquisitions and public listings.
In other words, PE firms are investing at extremely high levels in the U.S. economy but seem to also be relinquishing control of the firms they invest in at high levels. It makes little sense to apply the corporate minimum tax to smaller and mid-sized businesses that PE firms invest in, so long as those businesses are under the $1 billion threshold of the book minimum tax.