Private Equity Monitoring Fees as Disguised Dividends: Collateral Impact

Abstract

In an earlier article (The Untold Story of Sun Capital: Disguised Dividends, 142 Tax Notes 556 (2014)), I argued that in many cases monitoring fees paid by private-equity controlled companies should be recharacterized as nondeductible dividends. This recharacterization would increase the tax liability of portfolio companies because they deduct monitoring fees as compensation. In response, some have argued that the recharacterization of monitoring fees as dividends would also reduce the tax liability of private equity managers. This article argues that there would in fact be no tax benefit to the manager or to the vast majority of private equity fund investors. The recharacterization could in some cases provide a tax advantage to the small minority of private equity investors who are U.S. individuals but the advantage would be constrained by the overall limitation on miscellaneous itemized deductions and, in any event, would typically pale in comparison to the additional taxes due from the portfolio company.

Keywords: tax, private equity, monitoring fees, disguised dividends, Sun Capital