Tax Reform Impact on Buy-Side Transactions
There are many factors to consider when a buyer is evaluating a business for possible purchase. Buyers must consider the business’s existing cash flow, evaluate market competition, assess current levels of inventory and staffing, and determine the level of tax liability and risk associated with the business they are interested in purchasing.
The passage of the Tax Cuts and Jobs Act (TCJA) made due diligence and tax planning even more critical, adding or modifying several sections of the Internal Revenue Code that impact transaction structuring, pricing and negotiations. Overall, the TCJA adds significantly to the advantages for both buyers and sellers of businesses. Several different provisions will impact a buyer’s preference for an asset acquisition or a stock deal.
Below are some of the key changes impacting buyers because of the new tax law:
- Overall M&A landscape. Additional due diligence is now required to determine an optimal acquisition strategy for stock deals because enterprise value calculations will be more complicated. Additional work for stock acquisitions may push buyers more toward asset purchases.
- Lower effective tax rate (ETR). The corporate tax rate has been reduced from 35 percent to 21 percent, and the highest individual tax rate has been reduced from 39.6 percent to 37 percent. Non-corporate taxpayers are now allowed a deduction equal to 20 percent of qualified business income (QBI), bringing the individual rate of 37 percent down to 29.6 percent. Investments may move away from pass-throughs, making C corporations and asset acquisitions more attractive in some cases.
- Interest expense limitation. The new rule limits the net interest expense deduction to 30 percent of adjusted taxable income. Disallowed interest deductions may be carried forward indefinitely. This change will likely have a negative cash flow impact on debt financing and highly-leveraged transactions. Buyers may prefer a stock deal where the target has significant interest expense carryforwards to not lose the deduction.
- Temporary 100 percent expensing. 100 percent expensing is available for the purchase of certain depreciable tangible assets from unrelated parties in the year the transaction closes, including assets already placed in service. Asset deals will be preferred to take advantage of this provision until 2022.
- Net operating loss (NOL) limitations. NOLs arising in 2018 and later years cannot be carried back to prior years and can only offset up to 80 percent of taxable income, but they can be carried forward indefinitely. Because of this change, post-2018 NOLs are less valuable, which may lead buyers to prefer asset deals.
- Partnership technical terminations. A previous rule stated that an acquisition of more than 50 percent of a partnership’s capital and equity interests within one year caused the partnership to terminate, causing issues related to tax accounting to arise. With the repeal of that rule, partnerships can only terminate for federal income tax purposes if no part of any business, financial operation, or venture continues to be conducted by any of its partners.
- Accounting for advanced payments. Targets may have more §481 adjustments due to required method changes. A longer timeframe for negative adjustments will likely push buyers toward asset purchases.
Buying a business may be one of the largest transactions you make, so it’s important to understand your potential tax liability and where the advantages lie as you negotiate. If you are considering purchasing an existing business and are unsure how the new tax law might impact you, contact Patrick McGuire, Tax Principal, at 314.687.2389 or firstname.lastname@example.org.
To learn about our services for the private equity industry, contact Bryan Graiff, Private Equity Industry Group Leader, at email@example.com or 314.983.1390.