The 2017 Tax Cuts and Jobs Act is perhaps the signature legislation of the Trump administration. For individuals and joint filings, it completely overhauled the tax brackets as well as the amount to be paid. This is in addition to changes to estate tax deductions, revisions to deductions for large medical expenses and many other updates.
On the corporate side, there were significant changes as well. The top corporate tax rate took a permanent cut from 35 percent to a flat rate of 21 percent. Further, the corporate Alternative Minimum Tax was repealed, there were changes to corporate conversion rules, mandatory repatriation of offshore cash (requiring a one-time tax of 15.5 percent) and some capital contributions from state/local governments will now be considered income. For those engaging in major corporate transactions, like mergers or acquisitions, these new rules are having an impact on how those deals are structured.
According to a September 2018 note from PwC, these revisions to the tax code are changing how potential acquirers are looking at take over targets. The issue at hand is that these policy changes can impact the net present value of the firm up for sale. For example, the law changed to 100 percent expensing for certain business assets, a rule that will remain in place until January 1, 2023. Another major change affecting the M&A deal making is that, beginning this year, taxpayers can no longer fully deduct net operating losses. These and other can have a significant impact on valuation.
According to PwC, these new tax rules will impact the market, whether the deal is in stock, cash or other assets. As they note:
- Asset deals allow immediate expensing with new tax reform or a step up in value of certain assets.
- Stock deals allow the target’s net operating losses to be carried over and applied to future taxable income.
This legislation has done little to slow down interest in the M&A Market. In the first half of 2018, the value of U.S.-based deals reached $1.03 trillion, an all time high. According to Bob Saada and David Hall of PwC, “Mega-deals are happening at a rapid rate, with an average of two deal announcements each week.” The two also note that buyers will need to change their models because of limits for interest deductibility, potentially leading to cash flow reductions.
With these new tax policies in place, it will probably take some time to truly see the impact they have on the market place. But if early returns are any indication, the M&A market should remain strong in the near term, thanks in part to how new legislation has changed deal structures.