Policy Documents

The Negative Consequences for Iowa of an Enterprise Value Tax

Donald P. Racheter, Jennifer L. Crull and Amy K. Frantz –
April 1, 2012

As part of the Obama administration’s quest for additional revenue, they have proposed a tax aimed at business owners. While the Enterprise Value Tax (EVT) is no longer an immediate threat, the administration has made it clear that they have a deep interest in increasing the tax burden on business owners and job creators. EVT more than doubles the taxation of profits from the sale of partnerships. Currently, most profits generated from the sale of partnerships are taxed at the long-term capital-gains rate of 15 percent. Under the Obama administration’s proposal, these gains would be treated as ordinary income for which the top statutory rate is 35 percent.

Although the EVT was originally created to target partnerships in the financial services community, it has much broader implications on small businesses, including many of those located in Iowa. The EVT provision includes the following:

Rather than taxing 100 percent of the “goodwill” or “enterprise value” generated from the sale of a partnership as a capital gain, the EVT would tax some percentage of that value as ordinary income, which has a top tax rate of 35 percent, higher than the 15 percent capital-gains tax rate. “Goodwill” or “enterprise value” is the value of a partnership that is worth more than the value of the assets themselves if sold.

The EVT proposal would apply to partnerships that are defined as “investment service partnership interests” (ISPI). Obama’s American Jobs Act refers to ISPI as an interest in a partnership that conducts business primarily in any of the following ways:

(A) Advising about investing in, purchasing, or selling any specified asset.
(B) Managing, acquiring, or disposing of any specified asset.
(C) Arranging financing with respect to acquiring specified assets.
(D) Any activity in support of any service described in subparagraphs (A) through (C).

The main targets of the EVT proposals are real estate and investment partnerships; however it is anticipated that the proposal, if adopted, would impact a greater range of partnerships due to the broad definition of “specified assets.”

The proposed EVT is an off-shoot of the proposal to treat carried interest as ordinary income rather than a capital gain, and thus tax it at a higher rate. “Carried interest” is the share of the profits of a partnership that are not proportional to the partner’s capital contribution. This can include the contribution of knowledge or “sweat equity,” something that contributes to the partnership other than a financial contribution. Carried interest is currently taxed as a capital gain, and thus at the 15 percent tax rate. Proposed legislation would instead tax carried interest as ordinary income.

However, the EVT issue is very different from the carried interest issue. Carried interest relates to income that is received by the partners, while EVT would raise taxes on the sale of an asset. As Peter Orszag, then Director of the Congressional Budget Office (CBO), said in testifying before the House Ways and Means Committee on September 6, 2007, “it is important to distinguish two different levels of taxation: the taxation of annual operations over the firm’s life, and the taxation of gains realized by the partners if they sell the firm.”

Additionally, this punitive tax subverts the century-old original intention of the capital-gains tax which was created to encourage individuals, corporations, and partnerships to take risks to create new jobs, the very aim of Obama’s American Jobs Act. However, the proposed EVT would more than double the tax rate on entrepreneurs, thus significantly decreasing the willingness of such Americans to take such risks and create new jobs.

Through analysis of public data, our study quantifies the net impact an EVT would have on revenue and job creation both nationally and here in Iowa. Imposition of the EVT would cause the following just in our one state of Iowa:

1) A “slow-down” of sales of Iowa farm land and the resulting negative impact throughout the farm economy.
2) Loss of approximately 1,614 jobs within one year of imposition of the EVT (which could be higher than this estimate, given that we used very conservative assumptions).
3) An increase in the annual tax burden on entrepreneurs in the range of $151,000,000 to $226,000,000 (range depends on the sensitivity of assets and turnover rates to the EVT.)

These results are alarming for Iowa and are counterproductive to the purported objective of the American Jobs Act which is intended to create, rather than destroy jobs. This analysis should give policy makers serious pause before voting to adopt.