The Impact of Private Equity Ownership on Portfolio Firms’ Corporate Tax Planning

by Brad Badertscher, Sharon P. Katz & Sonja Olhoft Rego

Overview — Although private firms are important components of the U.S. economy, their tax practices remains largely unknown due to the lack of publicly available financial information. In recent years, private equity (PE) firms have been broadly criticized based on the substantial tax benefits enjoyed by their owners and managers. Editorials have inflamed public opinion by accusing PE firm owners and managers as having excessively low tax rates, and pointing out that the substantial wealth generated by PE firms can "pay for sophisticated tax planning," including the use of offshore investment companies based in tax havens. More generally, critics contend that PE firms aggressively manage their tax liabilities and those of their portfolio companies. This study investigates the latter contention. In particular, the authors look at whether private companies that are majority-owned by PE firms ("majority PE-backed firms") engage in more tax avoidance than other publicly traded and privately held firms. This may be the first study to compare the tax practices of firms with different private ownership structures. Key concepts include:

  • While majority PE-backed private firms significantly benefit from the tax shield generated by leverage, they otherwise appear less tax aggressive than public firms.
  • In contrast, private firms that are majority-owned by PE firms engage in more tax avoidance than both management-owned and minority PE-backed private firms.
  • On average, majority PE-backed firms pay 15 cents less income tax per dollar of pretax income than other privately held firms, even after controlling for losses and debt tax shields.

Author Abstract

This study investigates how private equity ownership affects corporate tax avoidance. Private equity (PE) firms have been accused of aggressively managing their own tax liabilities and those of their portfolio firms. We investigate the latter assertion based on a sample of private firms for which there is financial statement data available. We first document that firms significantly alter their tax avoidance patterns in anticipation of 'going public' and 'going private' transactions. We then find that majority PE-backed private firms engage in less book-tax nonconforming tax planning than public years; nonetheless, they exhibit substantially lower marginal tax rates. We attribute these results to the larger debt tax shields of majority-owned PE-backed firms, which reduce their need for nonconforming (i.e., more aggressive) tax strategies. Lastly, we examine how different private ownership structures (e.g., majority PE ownership vs. management-owned) affect tax planning at private firms. Our results indicate that majority-owned PE-backed firms engage in more book-tax conforming and nonconforming tax planning than other private firms. We attribute these results to the managerial sophistication and resources available to majority-owned PE-backed firms. Keywords: Private equity; ownership structure; tax avoidance; tax planning; tax aggressiveness; book-tax differences. 56 pages.

Paper Information