Dividends are subject to corporate taxes because they usually came out of retained earnings. In addition, until 2001 GPs had to pay ordinary income taxes, around 31 percent, on those dividends once they received them. Thus, each dollar of pre-tax income was taxed at nearly 80 percent before the GP could deposit their carry into their bank accounts.
In 2001, Congress cut the tax rate on most corporate dividends to 15 percent. Around this time, private equity firms began investing more equity into deals, then using dividend recap structures to rebalance the capital structure down the road. But at the end of 2010, when the tax break expires, this method is going to lose much of its appeal.
Perhaps in anticipation of this change, there has been an uptick in recaps in recent months. In February, software company Intergraph – backed by Hellman & Friedman, TPG Capital and JMI Equity – announced that it would pay a $350 million recap, according to Moody’s Investors Service. Kohlberg Kravis Roberts-, Bain Capital- and Merrill Lynch Global Private Equity-backed hospital operator HCA is also going to pay $1.75 billion.
Also this year, Quintiles Transnational – backed by Bain, 3i, TPG and Temasek – reportedly paid a $275 million dividend; Blackstone-backed Vanguard Health Systems paid a $300 million dividend; and TPG-backed LASIS Healthcare paid $120 million, according to The Wall Street Journal. KPS Capital Partners-backed HHI Holdings is also set to pay a dividend.