The House and Senate enacted “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (the “2017 Tax Act”) on December 22, 2017. The 2017 Tax Act was signed by the President on December 23, 2017.
While it is difficult to predict all the implications of the tax changes on merger and acquisition activity, private equity, and real estate, we have the following observations based on our analysis of the new law:
Overall Economic Impact
- The reduction of the corporate tax rates and the repeal of the corporate AMT should increase the amount of cash available for private investment and M&A activity in all sectors.
- The shift to a territorial tax system may result in the patronization of offshore cash for domestic investment.
- The increased budget deficit will continue to raise economic concerns, especially if the tax cuts are followed by increased infrastructure spending and pressure on entitlement spending.
Implications for M&A, Private Equity, and Real Estate
- Choice of entity decisions will require consideration of the need to accumulate capital at the corporate level compared with the desire to distribute income to owners. The effective tax rate for owners of pass-thru entities (partnerships, LLCs, and S corporations) continues to be lower than the combined double tax resulting from corporate and individual taxation on distributed earnings.
- The availability of the 20% deduction for REIT dividends will increase the attractiveness of REITs and REIT investment structures for real estate investments.
- The new expensing and accelerated cost recovery rules will encourage capital expenditures, and also make asset purchases more attractive to buyers than stock purchases.
- In an asset purchase, the buyer can expense 100% of the cost of depreciable property, elect 50% in lieu of 100% expensing for qualified property placed in service during the first tax year beginning after September 27, 2017, or elect normal depreciation over the useful life of the property as under prior law (MACRS).
- The lower corporate rates will reduce the value of deferred tax attributes, and lower the cost of deferred taxes on corporate balance sheets. Tax due diligence in M&A transactions will be critical.
- The benefit of tax free spinoff transactions will be reduced, possibly resulting in more taxable separations.
- The additional restrictions where a foreign corporation acquires a U. S. corporation and the former U. S. shareholders own 60-80% of the stock of the combined entity (the “inversion percentage”) will discourage future inversion transactions.
- The limitation on business interest deductions (business interest income, plus 30% of EBITDA for 4 years and then 30% of EBIT thereafter, plus floor plan financing interest) will decrease the attractiveness of highly leveraged acquisitions, particularly private equity transactions.
- Earnings stripping strategies, involving payments to non-U. S. affiliates in multinational groups, will be impacted by the base erosion anti-abuse tax (BEAT) provisions, requiring a careful review of intra-group financing structures.
- Carried interest structures are still attractive, without regard to the new 3 year holding period for long term capital gains treatment on the disposition of the partnership interests. The extended holding period does not apply to pass-thru gain from the disposition of partnership assets.
The following chart summarizes the key provisions of the 2017 Tax Act for mergers and acquisitions, private equity, and real estate, as compared to Prior Law. Unless otherwise noted, the new provisions are effective for 2018. Most of the individual income, estate, gift, and generation skipping tax changes will revert to prior law after 2025, unless extended by future legislation.
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