Leon Black recently posed a question whose answer will determine how profitable the new U.S. tax regime could make Wall Street firms like his Apollo Global Management LLC.
Publicly traded partnerships, such as Apollo, are taxed differently than corporations.
So should Apollo take advantage of the overhauled tax rules to pay less in taxes? Or should it use this chance to change to an Inc. from an LLC, which would increase its tax bill but allow it to attract investments from mutual funds that have previously been out of reach?
"We're still analyzing,'' Black told the Goldman Sachs U.S. Financial Services Conference Dec. 6. "It's an uncertain outcome.''
Either way, it's most likely a money-making outcome. The tax changes are a boon for private equity firms such as Apollo, where Black is chief executive officer.
The new lower corporate rate has made it possible for bigger publicly traded partnerships to consider the change. As it is, management fees, which typically account for 30% or more of their earnings, are already taxed at the corporate rate.
That will drop. The legislation scarcely touched the 23.8% rate paid on incentive fees, also called carried interest, which incur no additional levy when paid out to shareholders.
Double Tax
If the partnerships converted to corporations, the incentive fees would be hit with a second layer of tax when they're paid out.
That would push the combined tax rate on incentive income paid out as dividends to nearly 40%, according to Peter Furci, co-chair of Debevoise & Plimpton's global tax practice.
But it would also allow the newly minted corporations access to indexes, and therefore the mutual-fund and ETF markets.
About $2.2 trillion follows the S&P 500 Index, according to its website. As of June, $122.6 billion in assets tracked the Russell 2000 Index, the best-known small-cap U.S. stock index, and there was $1.1 trillion bet on Russell U.S. indexes overall, according to the company.
The bigger universe of investors would likely boost the trading multiples of the firms' stocks. It's unclear how big the economic benefit of increased ownership would be, so the question is whether it would make up for the higher taxes.
"There's no way to say how much multiple expansion you could get by converting," said Gerald O'Hara, who follows private equity firms for Jefferies Group. "That's the question here that I think these firms are wrestling with."
