As pusblished in the Pennsylvania CPA Journal (Summer 2021 | Volume 92, Number 2)
After the Tax Cuts and Jobs Act
(TCJA) of 2017, the Coronavirus
Aid, Relief, and Economic Security (CARES) Act of 2020, and several
new regulations, we once again find ourselves on the path of tax reconfiguration
arising from President Joe Biden’s agenda.
Biden’s tax plans, as they currently stand,
are quite comprehensive, with several new
provisions to go with the reversal or undoing of the tax code adjustments enacted
a few short years ago.
Whenever there are expected changes
to the tax code, uncertainty enters the
markets and creates challenges for both
investors and those involved in merger
and acquisition (M&A) discussions. The
uncertainty makes forecasting return on
investment even more critical; however,
it becomes extremely difficult unless
you possess a crystal ball. Regardless of
which aspects of the administration’s tax
plan get passed and which ones fall by
the wayside, there are two things that are
most likely to occur: tax rates are going up
and certain deductions will be going away.
These changes will impact both businesses
as well as the owners of those businesses.
Thus, there could be a near-term acceleration of dealmaking in an effort to
avoid an erosion of after-tax proceeds to
investors.
Corporate Taxes
One of the most significant changes being proposed is an increase to corporate
tax rates from 21% to 28%. This is not a
modest increase, but, if there is a bright
side, tax rates will still be below the preTCJA maximum rate of 35%. The hike
will undoubtedly put a strain on corporate
earnings, further decreasing the value of
target corporations and decreasing cash
flow available to corporations who may be
seeking a future acquisition. Furthermore,
Biden intends to reinstate a corporate
minimum tax (which was repealed by the
TCJA) on corporations with global book
income of $100 million or more. The tax
is aimed at larger corporations, but it will
likely be a factor in determining the value
of those corporations due to the potential
erosion of projected earnings.
Capital Gains Tax Rate
Similar to the corporate tax rate increase,
individuals may see the top ordinary
income tax rate restored to its pre-TCJA
level of 39.6% (currently 37%). For investors, the tax rate on capital gains could see
a huge spike from 20% to 39.6% for individuals earning over $1 million. Therefore,
an investor’s tax bill could nearly double
on any capital gains realized from the sale
of their business, a deviation from the
decades-old policy of granting favorable
tax treatment for capital gains. This is all
before considering the impact of state and
local taxes and the net investment income
tax. It not only affects individual investors
but also will significantly impact private
equity firms. Private equity firms, which
often use debt to leverage acquisitions, are
still reeling from the TCJA-enacted Section 163(j) interest expense disallowance
rules. They will be dealt another blow as
their profits are generally taxed at capital
gains rates.
Qualified Business Income Deduction
The TCJA enacted Section 199A in an
effort to level the playing field for smallbusiness owners (other than C corporations) with a deduction of up to 20%
on qualifying business income. The 20%
deduction – a response to the corresponding reduction of the corporate tax rate
– essentially lowered the effective tax rate
on pass-through income from S corporations, partnerships, LLCs, and sole proprietorships to 29.6% (or 37% individual
ordinary rate multiplied by 80%). Biden
has proposed eliminating the Section
199A deduction for those making more
than $400,000. For small-business owners
of pass-through entities looking to sell
the assets of their business, this could
create a sizable gain within the business
that would ultimately flow through to the
owners. If the 20% deduction is removed
for taxpayers exceeding the $400,000 cap,
the tax on the sale of that business could
increase significantly, forcing owners to
increase the selling price to receive the
same after-tax proceeds.
Takeaway
Business owners who may be considering
retirement or selling their business must
understand what the future looks like
from a tax perspective. Businesses on both
sides of the negotiating table already are
taking measures to model out the proposed changes to determine their impact
from a potential sale or acquisition. Many
experts think that even if some of these
proposed tax changes become law many
businesses will see a decline in stock
value; however, it is too early to conclude
how much due to a lack of details related
to the proposals. The businesses that benefited the most from certain aspects of the
TCJA and other recent regulations would
likely see the biggest decrease in value if
those benefits were scaled back. Taxpayers
must consider how the current administration’s tax plans would impact ongoing
M&A discussions and decide whether or
not to accelerate those discussions to close
the deal before proposed changes become
a reality – or at least factor the potential
impacts into their negotiations.
