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M& A Tax Talk Power shift, tax shift?

A change in presidential administrations often signals the possibility of changes in tax policy, and this is certainly true in the case of the current transition. This article provides a high-level overview of President Biden’s proposed tax law changes to corporate and individual taxes and the potential impact on M&A transactions if such changes are enacted.

Setting the stage policy documents to the public or deliver • Narrow majorities: House Democrats More than two months after the nation a substantial, tax-focused economic control 222 seats in the 117th Congress, went to the polls on Election Day, questions address. The proposals discussed herein compared with 211 for Republicans—a around who will control the levers of power are gleaned largely from statements on significantly smaller majority than over in the White House and on Capitol Hill are Biden’s campaign website, as well as from the past two years. Democratic victories now finally settled. Joe Biden became the comments made during Democratic primary in the two Georgia Senate runoff races nation’s 46th president at noon on debates, rallies, campaign speeches, on January 5 mean that Democrats January 20 and will be working with a and briefings to reporters. Additionally, and the GOP hold 50 seats each in that Democratic Congress. consideration will need to be given to the chamber. Democrats effectively control potential impact on state tax legislation that the Senate since Vice President Harris, A change in presidential administrations may ensue following any federal tax in her role as president of the Senate, often signals the possibility of changes in tax policy changes. will cast the tiebreaking vote whenever policy, and this is certainly true in the case lawmakers are deadlocked. Democrats’ of the current transition. President Biden Second, it’s important to note that tax slender majorities in both chambers will campaigned on a platform of ensuring that law originates in Congress, not the White leave leaders with little room for error as businesses and wealthy individuals pay House, so any legislation that is enacted into they navigate the sometimes conflicting “their fair share” in taxes. To that end, he law inevitably will reflect the priorities of priorities of lawmakers in the progressive has proposed modifying or repealing key congressional leaders. Democrats hold the and moderate wings of the party. provisions of the 2017 tax code overhaul majority in the House in the 117th Congress, known informally as the Tax Cuts and Jobs which officially convened on January 3, and Finally, the full impact of any tax law changes Act (TCJA, P.L. 115-97). Among other things, have a narrow majority in the Senate after enacted in the early days of the Biden he has called for increasing the top tax Sen. Kamala Harris became vice president administration will depend on whether rates on corporations and upper-income on January 20. This potentially provides those provisions take effect prospectively individuals (generally those with income an opportunity to enact some level of tax or are retroactive to January 1, 2021. greater than $400,000) and for phasing increases in the coming two years. But the Retroactive enactment of tax law changes out the deduction for certain passthrough shape, breadth, and timing of any legislative is uncommon and generally is viewed as business income. If signed into law, these proposals that advance on Capitol Hill are unlikely. Nonetheless, the potential risk that proposed changes may also affect M&A likely to be affected by: future tax changes might be retroactive transactions and other deal activity. prior to the date of enactment is something • Differing priorities:The Democratic that should be kept in mind. This article provides a high-level overview party has historically brought together of Biden’s proposed tax law changes to politicians with widely disparate views Higher rates and other tax increases corporate and individual taxes and the on many issues, including tax policy, and Biden proposes to increase the corporate potential impact on M&A transactions if finding common ground could prove to tax rate from 21 percent to 28 percent. such changes are enacted. However, be challenging in 2021 and 2022. While Further, he has called for a 15 percent some significant caveats are worth Democratic taxwriters are united in their minimum tax on book income for companies keeping in mind. public criticism of the Republicans’ 2017 that report net income of more than $100 First, very little detail is currently available tax overhaul, they have not, for the most million for financial statement purposes but on many of the proposals Biden has part, weighed in on many of the owe no US income tax. put forward. Over the course of the specific proposals Biden laid out during campaign, he did not release detailed tax his campaign. 1 M&A Tax Talk | Power shift, tax shift?

On the individual side of the tax code, after-tax cash proceeds of $72,000, resulting taxed at capital gains tax rates. If the gap Biden proposes to increase the top rate in $7,000 of additional tax versus current between ordinary tax rates and capital on ordinary income from 37 percent to its law; and the individual would recognize gains tax rates shrinks, tax sensitivities with pre-TCJA level of 39.6 percent for those with after-tax cash proceeds of $60,400, respect to structuring earnouts between taxable income greater than $400,000. resulting in $19,600 of additional tax versus buyers and sellers may become less Long-term capital gains and certain current law. Similarly, if an investment important. dividends would be taxed at ordinary rates fund treated as a partnership for federal Alternatively, businesses may become for individuals with income greater than $1 income tax purposes sells its interest in a more concerned with tax structuring million—an increase from the current top business today that was held for more than alternatives. For example, a buyer typically long-term capital gains and dividend tax rate three years, an individual investor (with favors a structure that is treated as an asset of 20 percent. Income from carried interests income of greater than $1 million) in a fund acquisition or deemed asset acquisition would also be taxed at ordinary rates. management partnership would generally because it may deliver a step-up in tax basis. (Under the TCJA, carried interests are taxed be taxed at the current capital gains rate of If the rates increase, the tax basis step-up at preferential long-term capital gains rates 20 percent versus 39.6 percent on his or her will drive incremental value by providing if held for more than three years.) In addition share of the “carried interest” income from additional deductions that would offset to raising the top individual rate, Biden the sale. taxable income subject to higher tax rates. proposes to tighten tax benefits currently Additionally, if Biden’s 15 percent minimum available to owners of large passthrough Importance of M&A future cash tax on certain businesses becomes law, entities, who are taxed as individuals, by tax analysis a corporation with net operating losses phasing out the deduction under section When planning for an M&A transaction, (NOL) and paying no US income tax may not 199A for taxpayers with income of more buyers and sellers should consider seem as attractive a target for acquisition. than $400,000. evaluating these proposed changes and Depending on how the 15 percent minimum the potential impact they may have on The current-law 37 percent top rate for tax is drafted, the new owner of the transactions now. The potential increase in individuals and the 20 percent deduction for corporation could be liable for taxes on the tax rates and value of future tax attributes, passthrough business income, both of which corporation’s financial income, even though such as NOLs and tax basis step-up, should were enacted in the TCJA, are currently the company may not have any taxable all be considered when projecting future scheduled to expire after 2025. income due to the NOLs. cash tax flows, analyzing potential M&A implications On the other hand, a business’s NOLs and outcomes, and considering appropriate There has been some acceleration of other tax attributes may become more tax planning alternatives. M&A deal activity in anticipation of these valuable as tax rates increase, because they International tax proposals proposed income tax rate increases. can be utilized to offset income that would Biden’s proposed increase in the corporate Business owners (corporations and otherwise be subject to the higher tax rates. tax rate would also have an impact on global individuals) that are contemplating such a The analysis of different structuring intangible low-tax income (GILTI) and foreign transaction may be motivated to close a alternatives may also change. If long-term derived intangible income (FDII). Biden transaction before the potential increase capital gains are taxed at ordinary rates (for proposes to increase the tax rate on GILTI to in tax rates. The following are simplified certain individuals), sellers may not be as 21 percent from 10.5 percent and eliminate examples to illustrate the impact of an concerned with structuring transactions the exemption of a 10 percent return on the increase in tax rates and do not contemplate to achieve capital gains tax treatment. For average adjusted basis of foreign tangible other taxes such as the net investment example, if a buyer or seller is considering property from GILTI. income tax or state-level taxes. If a an earnout (i.e., generally a contractual corporation sells today and recognizes gain Biden would encourage domestic commitment to make a future contingent of $100,000, the corporation will have after- manufacturing—and discourage offshoring payment if post-closing conditions are met) tax cash proceeds of $79,000 at current of US jobs and production activity— in a proposed transaction, the earnout rates. If an individual (with income of greater through a combination of tax penalties and could be taxed at ordinary or capital gains than $1 million) sells his or her business incentives. He has proposed an offshoring tax rates. If the earnout is considered today for capital gains treatment for tax penalty of 10 percent, on top of the 28 compensation (and, potentially, tax- $100,000 of gain, he or she would recognize percent corporate tax rate, on the profits deductible), generally the earnout payments after-tax cash proceeds of $80,000 at of foreign production (of either goods or will be taxed as ordinary income. If the current rates. Absent other possible tax services) that are intended for sale in the earnout is considered a deferred purchase changes, if Biden’s plan to increase the United States. Further, he would eliminate price (and, potentially, not tax-deductible), corporate and individual income tax rates US deductions associated with moving these generally the earnout payments will be becomes law, the corporation would realize operations offshore. Additionally, Biden

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has proposed an advanceable “Made in Tax credits and initiatives Conclusion America” credit of 10 percent that could be Biden proposes to expand the new Despite the present uncertainty over applied to several categories of qualifying markets tax credit and work opportunity how much of President Biden’s tax policy expenses, including those related to tax credit, create a new manufacturing agenda can advance through a closely returning production to the United States, as communities’ credit, and retain and reform divided Congress and get enacted into law, well as revitalizing existing closed or closing the Opportunity Zone program. significant tax law changes over the next manufacturing facilities, incrementally few years remain a possibility. Biden’s tax M&A implications increasing wages paid to US manufacturing proposals may affect M&A activity and These tax credits and initiatives may provide workers, and retooling facilities to transactions, including the timing and additional tax benefits to business owners advance manufacturing competitiveness structure of transactions, as well as the who grow their business and enter new and employment. level of activity and value of transactions. markets. Under the Opportunity Zone When planning for an M&A transaction or M&A implications program, corporations and individuals integrating a recently closed acquisition, With these proposed changes to may invest previously earned capital gains it is important to start evaluating the tax international tax, business owners may into certain communities and temporarily proposals the Biden White House puts continue to be motivated or incentivized to defer paying taxes on those capital gains. forward, modeling potential outcomes, and retain earnings and growth in the United Further, the taxpayer may also benefit from considering the appropriate actions to take States. When contemplating a strategic a basis step-up or permanent exclusion of if and when these proposals go from high- M&A transaction, US companies may capital gains, depending on how long the level plans and talking points to fully look to acquire domestic companies or investment is held for. As such, business framed legislation with substance and move a business’s operations back to the owners may be incentivized to expand effective dates. United States, though the complexity of and invest through the Opportunity Zone international tax implications merit careful program if they are able to defer their capital consideration as deals are considered gains, especially if those capital gains would and structured. otherwise be taxed at ordinary tax rates (as discussed above).

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Jonathan Traub Lindsay Wietfeld Jess Williams Megan Sullivan Washington National Tax Mergers & Acquisitions Mergers & Acquisitions Mergers & Acquisitions Tax Principal Tax Partner Tax Senior Manager Tax Senior Deloitte Tax LLP Deloitte Tax LLP Deloitte Tax LLP Deloitte Tax LLP [email protected] [email protected] [email protected] [email protected]

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Appendix: Summary of current and proposed tax law

Corporate and business tax proposals Issue Current Proposed Corporate tax rate 21% Increase to 28%

15% minimum tax on book income of companies reporting US net income >$100 million but owe no US income tax Foreign-source income Global intangible low-taxed Increase GILTI effective rate to 21%; potentially eliminate of US multinationals income (GILTI) earned by US- exemption for 10% return on average adjusted basis of based multinationals subject to a foreign tangible property; and calculate GILTI on a country- 50% deduction (effective rate of by-country basis 10.5%) through 2025 and a 37.5% deduction (effective tax rate of 13.125%) thereafter

Exemption from GILTI applies for a 10% return on average adjusted basis of foreign tangible property Offshoring and No direct incentives or Impose 10% “offshoring tax penalty” on profits of foreign redomestication of disincentives production (including call centers and services) intended US jobs for sale back into the United States; penalty would apply on top of proposed 28% corporate tax rate for a combined tax rate of 30.8% on any such profits

Deny deductions associated with moving jobs and production offshore and implement “strong anti-inversion regulations and penalties”

Create advanceable “Made in America” credit of 10% applicable to qualifying expenses such as those related to returning production to the United States, revitalizing existing closed or closing manufacturing facilities, incrementally increasing wages paid to US manufacturing workers, and retooling facilities to “advance manufacturing competitiveness and employment”

Establish a “claw-back” provision requiring a company to return public investments and tax benefits when they shed United States jobs and send them overseas

Eliminate incentives for pharmaceutical and other companies to move production overseas Tax havens, base Base erosion and anti-abuse tax Reduce incentives for “tax havens, evasion, erosion generally (BEAT) limits the ability of large and outsourcing” multinationals to shift profits from the United States by making deductible payments to their affiliates in low-tax countries

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Corporate and business tax proposals Depreciation 100% immediate expensing for No specific proposal; may be affected by proposed qualified property through 2022, minimum tax (see above) then phased down each year through 2026 to 20% (expires after 2026); special rules for longer- production-period property and certain aircraft Community and workforce development incentives Opportunity Zones (OZ) Allow tax-free capital gains for Reform OZ program by (1) requiring Treasury Department investments held at least 10 years, review of OZ projects to ensure incentives are only basis increase for investments held directed to projects providing “clear economic, social, and at least five years, and temporary environmental benefits to a community,” (2) requiring deferral of capital gains on existing recipients of OZ tax benefits to publicly disclose their assets placed in OZ funds; final investments and the impact on local residents, and (3) OZ designations were certified in providing incentives for Opportunity Funds to partner with June 2018; election to invest capital nonprofit or community-oriented organizations and jointly gains in an OZ expires Dec. 31, 2026 produce a community-benefit plan for each investment New markets tax credit Available for up to 39% of a Expand and make permanent project’s cost for investors in low- income community businesses, through 2020 Incentives for domestic No provision Establish a manufacturing communities tax credit for five manufacturing years to incentivize qualified investment in communities affected by mass job losses Work opportunity tax Available to employers for hiring Expand WOTC target hiring groups to include credit (WOTC) individuals from certain targeted military spouses groups who have consistently faced significant barriers to employment (scheduled to expire after 2020)

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Individual income- and asset-based tax proposals Issue Current Proposed Ordinary income Top rate of 37% through 2025 Restore top rate to 39.6% tax rates Additional 0.9% Medicare income tax applies to earned income >$250,000 for joint filers and $200,000 for single taxpayers Capital gains, dividends 20% tax rate applies to long- Tax long-term capital gains and dividends at ordinary term capital gains and qualified income rates for those with taxable income >$1 million dividends

Additional 3.8% net investment income tax applies to individuals with income >$200,000 and joint filers with income >$250,000

Exclusion from capital gains tax for up to $250,000 single filers/$500,000 joint filers on qualifying home sales Carried interests Treated as long-term capital gains if Tax at ordinary rates held for more than three years Passthrough income Generally taxed at owner’s Phase out section 199A deduction for filers with income individual rate with a 20% >$400,000 deduction under section 199A for domestic business profits; deduction expires after Dec. 31, 2025

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