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The Impact of Tax Reform on M&A Transactions

Tuesday, March 13, 2018

Berkery Noyes, a middle-market investment bank specializing in mergers, acquisitions, and corporate financings, is pleased to share with you this summary of recent changes to the tax code, which will have significant bearing on both buy-side and sell-side clients who are considering buying or selling a business or business assets.

We have collaborated with EisnerAmper LLP, one of the nation’s most respected accounting and tax consulting firms, to produce a thorough analysis of the legislation with particular emphasis on its impact on our M&A and corporate finance clients.

Major Take-Away

During a business cycle that was already extraordinarily favorable for M&A transactions, the Tax Cuts and Jobs Act (TCJA) adds significantly to the advantages for both buyers and sellers, creating historic opportunities.

Background

The Tax Cuts & Jobs Act (TCJA), enacted in December 2017, not only includes a dramatic reduction in the corporate tax rate, but numerous provisions that have the potential to spur M&A activity.

Key Provisions of the TCJA

  • The corporate tax rate decreases to 21% starting in 2018. Unlike changes to individual tax rates, which are due to sunset in 2026, the corporate tax reduction is permanent, meaning any future change will require an act of Congress. The corporate alternative minimum tax (AMT) has also been eliminated.
  • Under the TCJA, tax rates for individuals are generally lowered over seven brackets, featuring a top tax rate of 37%.
  • The TCJA provides a deduction of up to 20% for pass-through entities on qualified business income (QBI), subject to certain limits and restrictions.
  • Bonus depreciation provisions provide that the full cost of depreciable property purchased after September 27, 2017 and before January 1, 2023 will be immediately deductible. This will be a key M&A driver. In addition, qualified property can be “used” or “second-use” property. Bonus depreciation is subject to a phase-out after 2023.   
  • The generous bonus depreciation provisions under TCJA, particularly the applicability to second-use property, will likely generate immediate net operating losses (“NOLs”), which have also been impacted by TCJA. 
  • NOLs are no longer fully deductible. Starting January 1, 2018, deductibility of NOLs is capped at 80% of taxable income. However, unused NOLs may be carried forward indefinitely, but no longer can be carried back to prior years.
  • Immediate expensing and the short-life nature of the new bonus deprecation rules could provide an incentive for the acquisition of non-tech assets. Examples include data centers, manufacturing equipment, print mail companies, and others.
  • Business interest expense deductions are subject to new limitations. Alternative financing arrangements should be explored and leveraged buyouts may be impacted. Importantly, investment interest expense is not subject to this limitation. 
  • There is now a three-year holding period requirement for carried interests to be eligible for long-term capital gains treatment. Interests in a partnership issued before December 31, 2017 are not grandfathered.
  • Starting this year, employees of privately-held companies can defer income from stock or exercise of stock options for up to five years from the date of the transfer or the date rights to stock are vested, whichever is earlier.


Other Factors Impacting the M&A Climate

The TCJA arrives at a moment when overall economic conditions are already highly conducive to M&A activity. Among the key factors are:

  • Historically high corporate profitability, share values and investable cash
  • Unusually low interest rates for the time being
  • Strong overall economic growth
  • Mammoth cash overhang among strategic and financial buyers
  • High valuation multiples well in excess of typical multiples

Next Steps

Talk to a Berkery Noyes managing director about your unique situation. At no obligation, we will analyze your particular circumstances and advise you of your alternative courses of action.

Most of the provisions in the TCJA are due to sunset in 2024, although it is possible that a future Congress will enact revisions to the 2017 law which may extend or curtail provisions in the TCJA and may or may not impact the M&A climate. Similarly, we believe that the current business cycle could be nearing a peak, suggesting that the unusually strong valuations we are currently seeing may soon return to more typical levels.

In short, there may be no better time to consider an M&A or corporate finance transaction. We would like to be your partner in that process. To that end, please call us at 212-668-3022 for a confidential discussion.

About Berkery Noyes

Berkery Noyes is an independent investment bank that provides M&A advisory and financial consulting services to middle market companies in the information and technology industries. The firm offers skilled transaction management to publicly traded and privately held businesses and private equity groups in both sell-side and buy-side transactions. Berkery Noyes has managed over 500 transactions, ranging from several million to more than four billion dollars in value.