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Private Equity Firms Can Use Accounting Systems To Track Pre-Fiscal Cliff Moves

Many private equity firms are preparing for less favorable tax policies in 2013, and these financial institutions can use corporate budgeting software to account for their year-end strategies as they accelerate gains, refinance certain investments and move assets around.

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Many private equity firms are preparing for less favorable tax policies in 2013, and these financial institutions can use corporate budgeting software to account for their year-end strategies as they accelerate gains, refinance certain investments and move assets around.

Private Equity Taxes

The clients of private equity firms could easily be affected as the tax policies affecting high wage earners and those inheriting wealth expire at the end of 2012, according to Bloomberg. Many top executives in private equity firms could end up with larger bills from the IRS if their stake in the profits generated by buyouts - known as carried interest - ends up with higher taxes.

"They’re economics first," Sandy Presant, an attorney at Los Angeles, California-based Greenberg Traurig LLP, stated in reference to his clients that are private equity managers, the media outlet reports. "They're going to want to cash in by year end."

Private equity firms that are readjusting their finances in order to mitigate the risk of higher taxes can account for these changes more easily if they use the right software applications during this financial planning process. The intricate financial actions taken by these firms could be difficult to track without the use of the right technology.

Carried Interest  

Carried interest is a tax policy that has attracted significant interest over the past several years. Private equity firm Carlyle Group LP cofounder David Rubenstein predicted earlier in the month that taxation of carried interest would probably be contained in budget discussions following the elections, according to Bloomberg News.

"After the lame duck, we expect that comprehensive tax reform will likely be on the agenda of the new Congress and the president," Rubenstein stated during a conference call on November 8 that involved the firm's earnings, the media outlet reports. "Carried-interest taxation and a great variety of other issues will no doubt be addressed."

Private equity managers obtain most of their compensation in the form of carried interest, according to the news source. This carried interest is usually equal to 20 percent of the profits that these managers make using client funds. Since the profit is taxed like a capital gain, it receives a rate of 15 percent, less than half the 35 percent top rate applied to income.

The Joint Committee on Taxation predicts that if carried interest is taxed as ordinary income, it will result in an additional $16.8 billion in revenue over the next 10 years, the media outlet reports.

Private equity firms that want to compensate for this potential change in tax treatment might have an easier time if they use software during their budgeting process.

Accelerating Gains 

Jim Brown, a partner in the tax group at New York-based Willkie Farr & Gallagher LLP, stated that private equity managers may accelerate their gains on accrued carried interest so they can pay existing tax rates, according to Bloomberg. He said that one method to achieve this end involves a taxable transaction that moves general partner interests to an affiliate.

Brown said that "the idea of the strategy is to do something that accelerates the gain" on the stake that the general partner has in the underlying assets, the media outlet reports. He stated that once the intended gain is created, the remaining interest can be guarded from the higher rates.

He stated the professionals involved in such a transaction would generally establish the affiliate as either a S Corp or a C Corp in a foreign jurisdiction like the Cayman Islands so that the entity does not need to pay U.S. corporate taxes.

What is your private equity firm doing to prepare for the coming tax changes? 

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