Make sure clients are paying attention to short-term capital gains versus long-term under the three-year requirement for any current M&A transactions.
Be Aware of Business Interest Deduction Limitations
When considering leveraged buy-out acquisitions, clients must also consider the new business interest deduction rules and limitations, and how they will impact the operations of the business. Under the TCJA, business interest deductions are limited to 30 percent of earnings before interest, taxes, depreciation and amortization, but additional amounts can be carried forward.
This applies to businesses with over $25 million in average annual gross revenue for the past three years, regardless of business structure (C corporation or PTE). Real property and trade or business may elect out of the limitation if they choose a less advantageous depreciation method. Because outstanding debt is included, highly leveraged companies may be hard hit by this limitation of deductions for existing debt. This makes M&A transactions involving those businesses less desirable than in the past.
Prepare for Limitations on 1031 Exchanges
Under the TCJA, 1031 exchanges no longer apply to personal property. This is particularly an issue when a taxpayer has real property that also includes personal property.
For example, if a client is selling a 200-unit complex and buying a 400-unit complex in a 1031 exchange, now all the personal property is taxable in that exchange. This can include of office equipment, furniture, dishwashers, stoves, washers, dryers, drapes, tools and other equipment. Part of the transaction proceeds must now be allocated to personal property and reported accordingly, which can have a significant impact on real estate transactions.
Understand the Value of Asset Purchases
Asset purchases are likely to rise in 2018 and the following years, for reasons described below. However, stock purchase buyers can also benefit through tax code sections 338(h)(10) or 336(e). Qualifying taxpayers can treat a stock sale as an asset sale for tax purposes. This gives buyers the tax benefits of the immediate deduction for equipment and depreciable assets.
The TCJA not only eliminates the corporate alternative minimum tax, but it also dropped the corporate tax rate from 35 to 21 percent. In addition, individual tax rates have been reduced in most brackets with a new maximum rate of 37 percent.
Because of the lower corporate and individual tax rates, sellers may be more open to selling assets, since they stand to gain more than in previous years. At the same time, buyers are also attracted to asset purchases due to the tax code changes that let them immediately deduct equipment costs and depreciable assets.
Last year, small business transactions hit record highs, and that momentum is expected to continue through 2018. The TCJA can give buyers greater cash flow at the same time that the Small Business Administration has lowered the down payment to 10 percent (from 25 percent) for business acquisitions. Despite recent increases, interest rates are historically low. As mentioned above, the corporate tax rate was dropped to 21 percent (from 35 percent), individual tax rates have been reduced, and for the next five years, companies can expense 100 percent of expenditures on qualified property.
If clients are considering selling, they may want to:
Clean up their financials. Consider removing nonessential items such as underperforming segments, non-operating assets, shareholder loans and minority investors. This allows buyers to focus on the core strengths of the business.
Focus on strengths. Private business owners nearing retirement may lose the drive to grow their businesses and operate their companies as a ‘cash cow.’ However, buyers are generally interested in a company’s future potential. Achieving top dollar requires a tack-sharp sales team, a pipeline of research and development projects, well-maintained equipment and a marketing department that is strategically positioning the company to take advantage of market changes and opportunities.
Create a tax-aware offer package. With all the changes brought by the TCJA, sellers will want to make sure they offer potential buyers fixed asset registers and inventory lists, in addition to business plans and nancial projections, working capital analyses, quality of earnings reports and more.
Keep confidentiality in place. Before clients give out any information or allow potential buyers to tour their facilities, remind them to require a confidentiality agreement to protect their proprietary information.
If clients are buying, be aware that 2017 was even more of a seller’s market than 2016, with sellers realiz- ing, on average, 99 percent of their asking price. If they are paying top dollar for an acquisition, make sure they have considered the tax changes above and are structur- ing the deal to put themselves in the most advantageous position for years to come.
The list above does not detail all of the changes brought by the TCJA that could pertain to M&A transactions.
Doug Collins, CPA, is a partner with the accounting rm of Nisivoccia LLP in Mount Arlington. As partner leader of the real estate group, he provides tax and advisory services for real estate developers and investors, as well as construction contractors.