Understand Tax Regulations to Maximize ROI
The changes that occurred under the 2017 Tax Cuts and Jobs Act (TCJA) continue to impact businesses in multiple ways, and while some of these are favorable, others are not. More recently, the Coronavirus Aid, Relief, and Economic Security (CARES) Act further adjusted some of these rules. Businesses considering a transaction, such as a merger or acquisition, should be sure to consider the following.
Bonus Depreciation Phase-Out
What are the current depreciation limits?
Through bonus depreciation, taxpayers can deduct additional depreciation for the cost of qualifying business property. The goal of bonus depreciation is to help increase capital purchases and promote investment in property and equipment. Prior to the Tax Cuts and Jobs Act (TCJA), bonus depreciation only applied to new equipment. However, businesses can now include used equipment as long as it is considered “first use” by the business that purchased it. Bonus depreciation was at 100% for all qualified purchases made between September 27, 2017 and January 1, 2023. However, it dropped down to 80% this year and will continue to decline in the coming years. See the phase-out schedule below.
- 60% for 2024
- 40% for 2025
- 20% for 2026
- 0% beginning in 2027
As a result of these rules, structuring taxable transactions as asset purchases rather than stock acquisitions may result in an immediate deduction of a portion of the purchase price in the year of acquisition. If the transaction is structured as an asset purchase, rather than a stock purchase, the purchase price allocated to personal property is eligible for the increased Section 179 expense deduction of $1 million, as well as the Section 168(k) bonus depreciation deduction of 80% of the cost.
Interest Expense Limitations
What is the true cost of borrowing based on the interest limitations?
The TCJA also imposed limits on the amount of deductible interest expense to 30% of a business’s adjusted taxable income. To the extent that the interest expense is limited, it creates a carryover amount that does not expire, so it is a timing difference versus a permanent difference. However, this factor is important to consider when determining acquisition costs and how leveraged the company will become as a result of the transaction. Owners may want to consider alternative capital resources other than debt to fund the transaction, or, at a minimum, confirm that the limitation is factored in when determining the true cost of borrowing.
The tax code does provide an exemption from the interest limitations for:
- Businesses with average annual gross receipts of less than $25 million
- Farming
- Real estate businesses, assuming, in the case of real estate, the owner elects longer depreciation recovery periods
There has also been a temporary increase in the 30% limitation as a result of the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
Pass Through Loss Limitation
What is the unfavorable treatment of pass through losses and net operating losses?
Many business ventures generate tax losses in the first years of operation. Prior to the TCJA, these business losses were fully deductible on the individual’s tax return, and, if they resulted in the owner having a Net Operating Loss (NOL), allowed the loss to be carried back. However, under the TCJA legislation, owners were no longer allowed to deduct excess business losses in the year generated and NOLs were no longer allowed to be carried back. It’s important to note that, similar to the interest deduction rules, there have been some adjustments to these rules due to the CARES Act that apply retroactively to 2018 and 2019. That said, the rules revert back to those under the TCJA for NOLs and Excess Business Losses in years after 2020.
As a refresher, an excess business loss is defined as the excess of aggregate business deductions for the tax year over the sum of aggregate business income and gains for the tax year plus $250,000 (single) or $500,000 (married filing jointly). Essentially, this means that if the sum of all of a taxpayer’s flow-through businesses generate a loss of more than $500,000 (married filing jointly), the loss is limited at that amount. These losses are then able to be carried forward as a NOL.
The rules related to NOLs under the TCJA are:
- NOLs are now limited to 80% of the taxpayer’s taxable income
- Remaining amounts are available to carry forward indefinitely
- Businesses can no longer carry back any net operating losses
Continue the Conversation
The TCJA guidelines and modifications made by the CARES Act are complex and contain many nuances. Fortunately, a solid understanding of these issues will allow you the opportunity to negotiate transactions to your benefit. Contact us today to learn more about the current tax regulations and how to get the most ROI out of a merger or acquisition.
