Article

The Tax Advantage to Paying Private Equity Fund Managers with Profit Shares: What Is It? Why Is It Bad?

Chris William Sanchirico

Professor of Law, Business, and Public Policy and Codirector of the Center for Tax Law and Policy, University of Pennsylvania Law School, Wharton School, Business and Public Policy Department

For helpful comments, I thank Alan Auerbach, Alan Blinder, Mitchell Engler, Victor Fleischer, Mark Gergen, Kevin Hassett, James Hines, Mitchell Kane, Alex Raskolnikov, Julie Roin, Frank Sammartino, Daniel Shaviro, Joel Slemrod, Gene Seago, David Weisbach, Larry Zelenak, and participants at the University of Michigan’s Tax Policy Workshop Series and NYU’s Colloquium Series on Tax Policy and Public Finance. Special thanks to Reed Shuldiner and Michael Knoll for many useful discussions. This research was not supported by funding from any outside source. The working paper version of this Article was first circulated and posted on SSRN on June 25, 2007. See Chris William Sanchirico, The Tax Advantage to Paying Private Equity Fund Managers with Profit Shares: What is It? Why is It Bad? (University of Pennsylvania Institute for Law and Economics Research Paper No 07-14, June 25, 2007), online at http://ssrn.com/abstract= 996665 (visited June 8, 2008).

The prototypical “private equity” fund pools the capital of sophisticated investors, purchases ailing companies, restructures the companies, and then resells them—at a profit, if all goes well. In fact, all has gone extraordinarily well for some funds. Accordingly, the earnings of those who market and manage such funds are not only among the largest in the nation, but are so historically outsized as to inspire talk of a new Gilded Age. Yet, as the fortunes of private equity fund managers have grown, so too has the intensity of the scrutiny they have attracted from the press, Congress, and the academy. Calls for reform ring out from several sources concerning various aspects of the way in which these funds do business. One of the chief pressure points—and the one that seems to be of greatest concern to private equity firms themselves—is the income tax treatment of fund manager compensation.

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