Impact of Tax Reform on Mergers & Acquisitions
posted May 28, 2019 by Loree Dubois, CPA in the Global Tax Blog
Thanks to the Tax Cuts and Jobs Act (TCJA), many businesses will pay less federal income taxes in 2019 and beyond. Before your business decides to use these tax savings to merge or acquire another business, make note of how your transaction will be taxed under the current tax law.
M&A refresher- Stock vs. Asset purchase
Mergers and acquisitions (M&A) is the consolidation of companies or assets through various types of financial transactions.
An M&A deal can be structured in two basic ways from a tax viewpoint:
- Stock purchase- If the target business is operated as a C or S corporation, a partnership or limited liability company (LLC), a buyer can purchase the seller’s ownership interest.
- Asset purchase- Buyers can also purchase a business’ assets. If the target business is a sole proprietorship or a single member LLC that’s treated as a sole proprietorship for tax purposes, this is the only option. Note that in certain circumstances, a corporate stock purchase can be treated as an asset purchase by making a Section 338 election.
TCJA Changes impacting M&A
Reduction of corporate tax rate to 21% (from 35%)- Now that the TCJA established a flat 21% corporate federal income tax rate, buying C corp stock is more attractive for a couple of reasons:
Corporations will pay less tax and will generate more after tax income as a result.
Any built-in gains from appreciated corporate assets will be taxed at a lower rate when they’re eventually sold. This decrease in federal tax rate is expected to make the U.S. a more attractive jurisdiction for inbound M&A activity. It could also increase the value of U.S. domiciled businesses.
AMT Repeal- The TCJA also repeals the alternative minimum tax (AMT) on corporations, which gets rid of some of the complexity associated with U.S. corporate taxation. Corporations with AMT credit carryovers should make sure they are applying for a refund of outstanding AMT credits that exist as of December 31, 2017.
Participation exemption deduction for the foreign source portion of dividends- Expanding business through domestic acquisitions has become more attractive due to this TCJA change. The participation exemption deduction aims to encourage U.S. companies to repatriate foreign earnings and invest them domestically for investments. Instead of spending cash trapped offshore to acquire targets based in foreign markets, U.S. businesses can now use this repatriated cash for things like business expansion through domestic acquisition.
100% tangible asset expensing- The TCJA allows immediate 100% expensing of certain costs identified as tangible personal property and land improvements and applies to both new and used property. Check out our blog, Bonus Depreciation; How Building Improvements Fell through the Cracks. Given this change, asset or stock sales (subject to a Section 338(h)(10) election) may become more attractive, due to the availability of 100% bonus depreciation to buyers (on the portion of purchase price allocated to qualifying fixed assets), as well as the lower 21% tax rate now assessed on corporate sellers.
- Elimination of carryback of NOLs- Under prior law, net operating losses (NOL) could be carried back up to 2 years to recover tax payments, could be carried forward up to 20 years, and could offset 100% of taxable income. Under the TCJA, NOLs can now only offset 80% of taxable income and carrybacks are no longer allowed. NOLs incurred after December 31, 2017 can now be carried forward indefinitely, however. These changes may introduce new issues to sellers of portfolio companies looking to capture the benefit of M&A transaction deductions.
Given the numerous changes under the TCJA, it’s critical to seek professional tax advice as you negotiate a merger or acquisition.
Contact us for further guidance.