The Build Back Better Act: Implications of Tax Reform for Private Equity Mergers and Acquisitions | McDermott Will & Emery
On October 28, 2021, US President Joe Biden unveiled his $ 1.75 trillion lean infrastructure spending plan and congressional leadership released HR 5376 (the Build Back Better Act (BBBA)), which contains revised proposals for changes in tax law to pay for the various coins. of President Biden’s new agenda. The BBBA follows a set of proposals released by the House Ways and Means Committee on September 14, 2021 (W&M Proposal), and while it incorporates some of the tax law changes from the W&M Proposal, there are some notable differences ( including the complete absence of certain changes from the W&M proposal). Here is a brief summary of some BBBA concepts which, if adopted in their current form, would potentially increase the overall tax burden on certain parties involved in private equity merger and acquisition (M&A) transactions and may have implications. implications for year-end planning. .
- No price change: The W&M proposal includes increases to the highest rates for individuals and businesses, including a five percentage point increase in the rate applicable to long-term capital gains and eligible dividends. The BBBA removes any increase in the base personal and corporate tax rate, including any change in long-term capital gains rates. However, as explained in more detail below, this does not necessarily mean that parties engaged in M&A transactions will be exempt from significantly higher tax bills resulting from the closing of those transactions next year.
- No change of interest carried forward: The BBBA cancels the W&M proposal’s increase in the holding period (to five years) applicable to deferred interest to benefit from long-term capital gains rates. Thus, the current three-year holding period (and the related statutory structure of Section 1061 as originally enacted under the Tax Cuts and Employment Act) would remain the same. There are no other explicit proposals that deal with deferred interest agreements, so fund managers can rest more easily now that their incentive structures no longer do, at least for now, l object of attack.
- No income limitation for section 199A deduction: While the W&M proposal sought to limit the application of the 20% deduction for “qualifying business income” of unincorporated taxpayers under Section 199A of the Code, the BBBA is abandoning this proposal. As a result, previously proposed âhigh incomeâ caps that could impact high income partners of a partnership or shareholders of an S corporation are no longer on the table.
THE WRONG: THE MEDICAL TAX OF 3.8% APPLIES STILL WIDER AND OTHER DEVELOPMENTS FAVORABLE FOR SMALL BUSINESSES
- Expansion of net investment income tax: The BBBA largely without change adopts the expansion of the W&M Net Investment Income Tax proposal of 3.8% starting in 2022. The proposal closes a perceived “loophole” by submitting all commercial income or business persons with incomes greater than $ 400,000 (individual) or $ 500,000 (married couples) to 3.8% net income tax, except to the extent already subject to labor tax independent. This is an unfavorable change for owners of limited partnerships or S corporations who âmaterially participatedâ in the business and were not previously subject to 3.8% tax or tax. on self-employment (other than self-employment tax on owners of âreasonable remunerationâ S companies as an employee) and, as discussed below, in particular in a sales transaction.
- Reduced QSBS Benefits: The BBBA would also keep the changes to the W&M proposal to materially limit the benefits for owners of âqualified small business stocksâ (QSBS). The BBBA would reduce to 50% the 100% earning exclusion (in effect since 2010) for any sale or exchange of QSBS occurring after September 13, 2021 (unless a binding contract has been entered into on that date and is not subsequently modified in all material respect). However, individuals with an adjusted gross income of less than $ 400,000 would continue to be eligible for the 100% exclusion. As with the W&M proposal, there are no grandfather rules for QSBS owners as of the proposed effective date. Thus, all current and future high income investors in QSBS will only be entitled to a reduced 50% earning exclusion on future sales and trades, which will have a significant impact on the expected tax benefits of a investment in such companies.
- No free S Corp release: The BBBA is removing a provision from the W&M proposal that would have given qualifying S corporations a limited window to reorganize into a tax-free partnership. The original proposal was worded narrowly, but like so many aspects of the BBBA, there’s no free lunch here.
THE UGLY: 5 – 8% SURCHARGE ON HIGH-INCOME TAXPAYERS AND 15% MINIMUM TAX ON LARGE COMPANIES
- Supplement for high income taxpayers: The BBBA would impose new “surcharges” on individuals, estates and trusts whose modified adjusted gross income (MAGI) exceeds certain thresholds. These additional taxes would apply for tax years beginning after December 31, 2021. The surcharge is 5% or 8% (e., the initial 5% plus an additional 3%) on the taxpayer’s income exceeding the applicable thresholds indicated in the table below. This surcharge would apply to many family sellers or founders in private equity M&A transactions.
|5% surcharge||8% surcharge|
|People||$ 10,000,000||$ 25,000,000|
|Estates or trusts||$ 200,000||$ 500,000|
- Minimum corporate income tax: The BBBA would introduce a new minimum corporate income tax, which would impose a minimum tax of 15% on the accounting profits of corporations (other than S corporations, regulated investment firms and real estate investment trusts) that report in average over $ 1 billion in adjusted financial statement earnings over a three-year period. For this purpose, a taxpayer’s financial statement would include a financial statement on a Form 10-K filed with the United States Securities and Exchange Commission (SEC) and, in the absence of such a financial statement, a financial statement used for tax purposes. The $ 1 billion threshold is determined after the consolidation of certain companies under common ownership or control, so the minimum tax may apply to companies other than large multinationals (such as holding companies of private equity funds). -investment). The minimum corporate income tax would apply to taxable years beginning after December 31, 2022.
IMPLICATIONS OF YEAR-END PLANNING FOR PRIVATE EQUITY M&A TRANSACTIONS
Several changes included in W&M’s proposal that would have negatively impacted parties in ordinary private equity merger and acquisition transactions are notably absent from the BBBA. However, if the BBBA were adopted as proposed, these taxpayers would not come out unscathed. Of particular importance to sellers, the surtax on income exceeding the applicable thresholds, together with the widening of the net investment income tax of 3.8% to be applied to gains from the sale of companies in sponsorship or S corporations, could increase the tax liability on a portion of the gain recognized for transactions that close in 2022 or later in up to 11.8 percentage points compared to those that close before the end of the year. However, for transactions for which a 2021 closing is not possible, the parties might consider engaging in certain pre-closing restructuring transactions designed to expedite the recognition of gains until tax year 2021. Sellers who would otherwise have income below the surtax thresholds but for taxable income resulting from a sales transaction may also consider structuring the transactions as installment sales in order to spread the gain from the sale over two or more years. in order to avoid the surcharge.
 For a married person filing a separate return, the 5% surtax applies to the person’s MAGI over $ 5,000,000 and the 8% surtax applies to the person’s MAGI over $ 12,500,000.