M&A and Tax Reform: New Deal Structure
Considerations Capital Expensing, Transition Tax, Business Interest Deduction, NOL Carryforwards,
Executive Compensation and More
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THURSDAY, MARCH 15, 2018
Presenting a live 90-minute webinar with interactive Q&A
Griffin H. Bridgers, Atty, Hutchins & Associates, Denver
Russell A. Daniel, Partner, Grant Thornton, Charlotte, N.C.
Scott P. Greiner, LL.M. (Tax), Partner, Moye White, Denver
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M&A and Tax Reform:
New Deal Structure
Considerations
Scott P. Greiner J.D., LL.M. (Taxation)
Attorney, Moye White LLP
303 292 7942
Presented by
Copyright © 2018 Moye White LLP. All rights reserved.
TAX CUTS AND JOBS ACT OF 2017
Most extensive tax law change since 1986
Approved by the House on November 16, 2017
TCJA constrained by Senate budget reconciliation
rules Can’t exceed $1,500,000,000 deficit over next 10 years
House and Senate approve Conference Committee
bill on December 20, 2017
Signed into law on December 22, 2017
Effective January 1, 2018
6
OVERVIEW AFFECTING BUSINESSES
Permanent tax reform for C corporations Prior to TCJA, a C corporation’s taxable income was taxed at
graduated rates reaching upwards to 35%
Beginning 2018, the taxable income of all C corporations is
permanently lowered to a flat rate of 21%
Prior law’s 20% corporate alternative minimum tax on certain tax
preference items is permanently repealed
Dividends received deduction reduced to 65% (from 80%) for 20%
shareholders and to 50% (from 70%) for less than 20%
shareholders
7
OVERVIEW AFFECTING BUSINESSES
Temporary tax reform affecting sole proprietors and
business owners of pass-through entities Effective for taxable years 2018 through 2025
Top individual rate drops from 39.6% to 37% for married individuals
filing jointly having taxable income in excess of $600,000, and for
unmarried individuals with taxable income in excess of $500,000
Individual AMT exemption and phase-out thresholds increased
For joint filers, by $24,500 from $84,500 to $109,400
For unmarried individuals, by $16,000 from $54,300 to $70,300
Exemption phase-out threshold temporarily raised to
$1,000,000 for joint filers and to $500,000 for unmarried
individuals, all as indexed for inflation starting 2019
8
OVERVIEW AFFECTING BUSINESSES
New IRC § 199A 20% pass-through entity business
deduction Effective for taxable years 2018 through 2025
“Qualified business income” defined
W-2 wage limitation
Thresholds and phase-in
“W-2 wages” defined
Specified service trade or business limitation
“Specified service trade or business” defined
Thresholds and phase-outs
Overall limit based as taxable income reduced by net capital gain
9
OVERVIEW AFFECTING BUSINESSES
Profit interests (colloquially, carried interests) and
new 3-year holding requirement Re-characterizes LTCG as STCG taxed as OI
“Applicable partnership interest” defined
“Applicable trade or business” defined
“Specified assets” defined
Taxation of related party transfers
Covers existing and newly granted carried interests
10
NET OPERATING LOSSES
Prior to TCJA, NOLs could be carried back 2 years
and carried over 20 years offsetting 100% of taxable
income
For NOLs generated after 2017, they can no longer
be carried back, but can be carried forward
indefinitely, limited however, to 80% of taxable
income Certain farming NOLs can still be carried back 2 years
For property and casualty insurance companies, TCJA permits a 2-
year carryback and 20-year carryforward of NOLs
11
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Conversion to territorial tax regime
Tax Analysis
• Untaxed earnings and profits ("E&P") of
foreign subsidiaries (as of wither 11/2 or
12/31/17) will be required to be included in
income.
• Tax is payable over an 8 year period,
beginning in 2018.
• Dividends received from non-U.S.
subsidiaries thereafter will be subject to a
100% dividend received deduction (with
certain exceptions).
• Future cash repatriation from non-U.S.
subsidiaries to domestic U.S. corporations
will be more efficient from a tax perspective
– but must consider impact of GILTI
(discussed later)
Seller Insights
• Buyers will be scrutinizing any planning
done by sellers to reduce or eliminate E&P
for compliance with the new provisions.
• Allows more efficient use of cash held
outside the US in transactions.
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Treatment of deferred foreign income (One-time tax)
Amended Sec. 965 – Treatment of Deferred Foreign Income Upon Transition to Participation
Exemption System of Taxation
• Generally requires that:
• for the last taxable year beginning before January 1, 2018
• of any deferred foreign income corporation
• any U.S. shareholder of a must include in income
• its pro rata share of the accumulated post-1986 deferred foreign income
• as an increase to subpart F income as otherwise determined under Section 952
• Effective date – Effective for the last taxable year of a foreign corporation that begins before
Jan. 1, 2018, and with respect to U.S. shareholders, for the taxable years in which or with
which such taxable years of the foreign corporations end
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Section 965 Guidance Issued
On Dec. 29, 2017 the IRS and Treasury Issued Notice 2018-07
• Notice 2018-07 provides that regulations will be issued regarding:
• Determination of the Aggregate Foreign Cash Position
• Determination of accumulated Post 1986 Deferred Foreign Income
• Application of Section 961 to amounts treated as Subpart F under Section 965
• Treatment of Affiliated Group making a Consolidated Return under Section 965
• Determination of Foreign Currency Gain or Loss under Section 986(c)
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One-time tax - Measurement
• Deferred foreign income is determined on certain
measurement dates (Nov. 2 or Dec. 31, 2017
whichever is greater)
• Deficits are taken into account as of Nov. 2, 2017
only
• Income and Deficit foreign subsidiaries are
aggregated at a U.S. affiliated group level to
determine the aggregate foreign deferred income
• U.S. affiliated groups as defined under Sec.
1504
• Hovering deficits are available to absorb current
year earnings and profits
The Measurement
Date
Greater of E&P balance on:
Nov. 2,
2017
Dec. 31,
2017 OR
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One-time tax - Rates
• Rate of tax:
• 15.5% for cash & equivalents (cash position),
and
• 8% for the remainder of E&P
• Tax rate is achieved by means of a rate equivalent
deduction from the Subpart F income inclusion to
achieve the appropriate effective tax rate
• Indirect Foreign tax credits allowed after a haircut
• Carryforward FTC are allowed
• Election available to preserve NOLs
• 8-year installment period election – escalating
instalments of 8% in years 1-5,15% in year 6, 20%
in year 7, and 25% in year 8
Cash and cash
equivalents
(liquid assets)
Other assets
(illiquid assets)
Rates
8% 15.5
%
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One-time tax – Cash position
• Cash is measured as the greater of the U.S. shareholder's pro rata share of the aggregate
cash positions on:
1) the close of the last tax year beginning before 2018, or
2) the average of the cash position determined as of the close of the last two taxable
year of each specified foreign corporation ending before November 2, 2017
• Cash position is the aggregate:
• cash,
• account receivables, and
• the fair market value of certain property including: personal property which is publically
traded, commercial paper, certificates of deposit, securities of federal state or foreign
governments, foreign currency, and short term obligations which mature in less than one
year
• Cash positions may also include any asset which treasury describes as being economically
equivalent to cash by regulation
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Example - Measurement
Effect of Deficits on Distributions
U.S. Parent
CFC 1
(Deferred foreign
income corporation)
CFC 2
(E&P deficit foreign
corporation)
Allocation of deficit
for computation of one-
time tax
Dividend of earnings
shielded by deficits from
CFC 2
Sec. 965(b)(4)(A) provides
that E&P reduced by deficits
is treated as Sec. 959 PTI
Thus, distributions would be
treated as coming out of PTI
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One-time tax – S corporations
• Special rules exists for S corp that would defer the one-time tax
• Any shareholder of S corp may elect to defer his/her portion of the net tax liability until the
shareholder’s taxable year in which a triggering event occurs
• The S corp is required to report the amount includible, as well as the amount of deduction
that would be allowable, and provide a copy to its shareholders
• Deferred tax must be reported annually by the S Corporations shareholders
• The election to defer the tax is due no later than the due date for the return of the S corp for
the year that includes the one-time tax
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One-time tax – S corporations
• Three types of events may trigger an end to deferral of the net tax liability:
(1) the corporation ceases to be an S corp,
(2) liquidation or sale of substantially all corporate assets, a cessation of business, or
similar event, and
(3) transfer of shares of stock in the S corp by the electing taxpayer, unless the transferee
of the stock agrees to be liable for net tax liability
• Upon triggering event the S Corporation shareholders can make an installment election to
pay the tax over eight years
• The S corp and the electing shareholder are jointly and severally liable for any net tax
liability
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Cost recovery provisions
Analysis
• The bill provides for 100% bonus
depreciation (i.e. immediate expense) for
property placed into service after September
27, 2017 and before January 1, 2023.
Thereafter, the bonus rate phases down
over 5 years to zero.
• A key element is that the definition of
property includes used property.
Seller Insights
• There may be an increased use of asset
acquisitions over stock acquisitions,
especially in capital-intensive businesses,
since purchase price is then immediately
deductible
• Buyers in asset acquisitions may realize
immediate, significant tax benefits.
• Purchase price allocation and valuation
issues will become increasingly important
22
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Capital gain vs ordinary tax on intangibles
Tax Analysis
• The bill repeals capital gain treatment for
certain intangibles, including a patent,
invention, model or design, secret
formula, or process, which is held either
by the taxpayer who created the property
or a taxpayer with substituted or
transferred basis
Seller Insights
• Sellers of intangibles must carefully
consider the proper gain treatment under
the new tax law – significant potential
ordinary income.
• This could have a significant impact on
purchase price allocation and valuation
issues.
• Even sellers of acquired intangibles may
be subject to ordinary gain treatment if
they received substituted or transferred
basis from a previous owner of the
intangible.
23
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Pass-through Deduction
Tax Analysis
• New Section 199A provides for a possible
20% deduction for non-corporate owners
of pass-through entities on qualified
business income
• Deduction is limited by the greater of (i)
50% of the individual’s share of the W-2
wages paid by the business to employees
OR (ii) 25% of such W-2 wages plus
2.5% of the unadjusted cost basis of the
business’s “qualified property”.
Seller Insights
• This deduction has more of an impact on
the operation of a pass-through than the
sale of one.
• Sale will create capital gains, which do
not qualify for the deduction.
• Ordinary income on an asset sale may
qualify.
• Pass-through sellers should consider the
structure of compensation agreements in
a manner that qualifies as W-2 wages –
to maximize their pass-through
deduction.
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C Corp vs Passthrough
Tax Analysis
• Due to the C Corp tax rate reduction, many
pass-through entities are analyzing whether
they should convert to a C Corp.
• See example on next page
Seller Insights
• C Corp seller will no longer be able to
negotiate compensation for the buyer's
receipt of stepped-up tax basis of acquired
assets.
• Should tax law change in the future, it will
be more difficult to convert back to a pass-
through
• Consider blocker structures
• Companies not distributing income are
more likely to convert to C corp status due
to much lower cash flow needed for taxes
• If company is planning to sell, the tradeoffs
are quite dramatic.
25
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C Corp vs Passthrough Operating years
• Assume Company will make $100 million of taxable income over the next 10
years, and does not distribute to shareholders (other than for taxes).
• As a C corp, it would owe $21 million of taxes.
• As an S corp that qualifies for the pass-through deduction, it owes about $29.6
million of taxes - $8.6 million higher.
• Without the passthrough deduction, the S corp would owe $37 million - $16
million higher.
Quick conclusion? Short term, being a C corp saves this company significant
cash.
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C Corp vs Passthrough Stock Sale
• After 10 years, the sellers sell their stock in a taxable transaction for $300 million.
Assume C corp stock basis is zero.
• As a C corp, the shareholders have a $300 million capital gain, and they owe tax of
$71.4 million (including 3.8% tax). Net proceeds are $228.6 million.
• S corp shareholders have $100 million more basis, so their tax bill is $23.8 million lower
than the C corp at year 10. Shareholders net $252.4 million.
• They already paid tax on this $100 million – either $9.6 or $17 million depending on
the passthrough deduction.
• Time value of money will be important.
Conclusion? If you're selling stock, the math gets a lot tougher, as you're trading less tax
currently for more in the future.
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C Corp vs Passthrough Asset Sale
• Now, instead assume that after 10 years, the sellers sell their ASSETS in a
taxable transaction for $300 million. All other facts are the same.
• C corp has a $200 million gain, meaning $42 million of tax due. Net $258
million is distributed to shareholders, who owe tax of $61.4 million. After tax
cash to shareholders = $196.6 million.
• S corp shareholders still pay one level of tax, largely at cap gains rates. They
owe the same tax as in the stock sale and net $252.4 million.
Conclusion? It won't make sense to sell C corp assets, and if you have to sell
assets, you're far better off as a passthrough. C corp sellers will still sell stock.
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C Corp vs Passthrough Overall takeaways
• Passthrough entities will cost more cash up front, but still have a lot of appeal
over the long run.
• If the company qualifies for the 199A deduction, you're paying an extra 9% up
front but will save 20% on the sale.
• If the company doesn't qualify for 199A, your taxable earnings end up netting
out over the long run….
• …but don't sleep on "untaxed value buildup" inside the corporation!
• Passthroughs can offer a basis stepup to buyers on this buildup, while it
generally will be very expensive for C corps.
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TAX LAW CHANGES: SALE OF U.S.
PARTNERSHIP INTEREST BY NON-U.S.
PERSON Presented by:
Griffin H. Bridgers
Hutchins & Associates LLC
Denver, CO
Sale of Partnership Interest by non-U.S. person • Under Grecian Magnesite v. Commissioner, 149 T.C. 3 (2017),
redemption of interest in U.S. LLC owned by foreign corporation was characterized as capital gain not effectively connected with a U.S. trade or business, which is not subject to U.S. taxation
• Opinion ignored Rev. Rul. 91-32, which uses “aggregation theory” to treat foreign partner’s disposition of interest in partnership engaged in U.S. trade or business through fixed place of business in U.S.
• Opinion instead applied entity theory to sale of partnership interest, finding that Subchapter K in its totality generally supports such treatment except with respect to real estate (covered under FIRPTA)
Sale of Partnership Interest by non-U.S. person • TCJA has legislatively reversed the result in Grecian Magnesite and
applied rules similar to FIRPTA to the sale of U.S. partnership interest by non-U.S. person
• If sale of partnership assets would generate U.S. effectively connected income, foreign partner must pay tax on share of such ECI allocated to partnership interest being disposed of
• Purchaser of interest must withhold 10% of gross purchase price on sale of partnership interest, including assumption of debt
Sale of Partnership Interest by non-U.S. person • Implications
• Purchaser of partnership interest must now get general non-foreign affidavit from seller, in addition to non-foreign FIRPTA affidavit for partnerships which own real estate
• In absence of affidavit, purchaser must withhold 10% of gross purchase price
• For non-cash transactions, purchaser must have sufficient cash to pay withholding
• If purchaser does not pay, partnership must do so
NEW EXCESS BUSINESS LOSS LIMITATION
Effective for taxable years 2018 through 2025
An “excess business loss” is a non-corporate
taxpayer’s aggregate trade or business deductions,
less the sum of aggregate trade or business gross
income or gain, plus $500,000 for joint filers or
$250,000 for all others, both as indexed for inflation
starting 2019
Applies at the shareholder or owner level rather than
at the entity level
Disallowed losses are treated as NOLs
34
INTEREST DEDUCTION LIMITATION
Generally, for each taxable year, business interest
expense of every business, regardless of form, will
be limited to the sum of: Business interest income, plus
30% of a business’ adjusted taxable income, plus
Floor plan financing interest
Any excess business interest expense disallowed in
a taxable year is carried forward indefinitely, subject
to certain restrictions applicable to partnerships/LLCs
and S corporations
Applies to business interest on all existing
indebtedness, as well as debt incurred after 2017
INTEREST DEDUCTION LIMITATION
What is “business interest”? Any interest paid or accrued on indebtedness properly allocable to
a trade or business, exclusive of investment interest
What is “business interest income”? Amount of interest included in gross income properly allocable to a
trade or business, exclusive of investment income
PLANNING NOTE: The “investment interest” rules under IRC § 163(d) only apply to
non-corporate taxpayers
Corporations do not have investment interest or investment income
within meaning of IRC § 163(d)
INTEREST DEDUCTION LIMITATION
What is “adjusted taxable income?” It’s taxable income computed without regard to:
Any item of income, gain, deduction or loss not properly allocable to
a trade or business
Any business interest or business interest income
The amount of any NOL
The amount of any deduction under new IRC § 199A
For taxable years 2018 through 2021, any deductions allowable for
depreciation, amortization or depletion
Since not reduced by depreciation, amortization or
depletion for taxable years beginning before 2022,
adjusted taxable income will be higher; therefore,
more business interest will be deductible
INTEREST DEDUCTION LIMITATION
What is “floor plan financing interest”? Interest paid or accrued on floor plan financing indebtedness
What is “floor plan financing indebtedness”? Indebtedness used to finance the acquisition of motor vehicles held
for sale or lease to retail customers that is secured by the acquired
inventory
“Motor vehicle” means: Any self-propelled vehicle designed for transporting persons or
property on a public street, highway or road
Boat
Farm machinery and equipment
Does not include construction machinery or equipment
INTEREST DEDUCTION LIMITATION
Generally, determined at the tax filer level
Special rules apply to pass-through entities Determination to be made at the entity level rather than at the S
corporation-shareholder, partner or member level
Means limitation is calculated separately for each pass-through
entity
Applies to high revenue, highly leveraged businesses
PLANNING ALTERNATIVE: Have a partnership/LLC issue preferred equity with a priority return,
i.e., pseudo-interest, as a substitute for certain types of debt, e.g.,
subordinated debt
Distribution of the priority return to the preferred equity holders
would leave the other equity holders in the same economic/tax
position as if the partnership/LLC paid deductible interest
INTEREST DEDUCTION LIMITATION
5 Exceptions: Limitation does not apply to non-tax shelter businesses with
average annual gross receipts for the 3-taxable-year period (or the
period in existence, if less) ending with the prior taxable year that
do not exceed $25,000,000
Limitation does not apply to certain regulated public utilities
At election of real property trade or business, limitation does not
apply to any development, redevelopment, construction,
reconstruction, acquisition, conversion, rental, operation,
management, leasing, or brokerage trade or business, including
that conducted by a corporation and REIT
In making the election, business must forgo deduction for
bonus depreciation
Election requires depreciation of the following real properties
using the alternative depreciation system (ADS):
INTEREST DEDUCTION LIMITATION
Non-residential real property: 40-year ADS recovery period
Residential real property: 30-year ADS recovery period
Qualified improvement property: 20-year ADS recovery period
At election of farming business, limitation does not apply to any
“farming trade or business” as defined in IRC § 263A(e)(4)
In making the election, farming business must forgo deduction
for bonus depreciation
Election requires that any property with a recovery period of 10-
years or longer use ADS
At cooperative’s election, limitation does not apply to any business
engaged in the trade or business of a specified agricultural or
horticultural cooperative as defined in IRC § 199A(g)(2)
CAUTION: the last 3 elections must be made in accordance with
rules prescribed by the IRS and are irrevocable once made
INTEREST DEDUCTION LIMITATION
Treatment of disallowed business interest
carryforward in corporate acquisitions Per IRC § 381, in connection with complete liquidations of
subsidiaries per IRC §332, or in connection with an acquisitive
reorganization described in IRC §§ 368(a)(1)(A), (C), (D), (F) or
(G), the acquiring corporation succeeds to and takes into account
any carryforward of disallowed business interest as of the day of
distribution or transfer for use in taxable years ending after such
date
Any carryforward of disallowed business interest is also subject to
the limitation on use of NOL carryforwards following an ownership
change as described in IRC § 382
TAX LAW CHANGES: DEDUCTIBILITY OF
EXECUTIVE COMPENSATION
Presented by:
Griffin H. Bridgers
Hutchins & Associates LLC
Denver, CO
Changes to Executive Compensation under IRC 162(m) • Pre-TCJA
• Applicable employee remuneration of covered employee of publicly held corporation not deductible to the extent it exceeded $1,000,000 in a tax year
• Summary of TCJA changes - new definitions for the following terms: • Applicable employee remuneration
• Covered employee
• Publicly held corporation
44
Changes to Executive Compensation under IRC 162(m) • Definition of applicable employee remuneration
• No longer excludes the following types of compensation:
• Commissions
• Other remuneration payable on basis of attainment of performance goals, including stock options
• Still can exclude the following:
• Payments to qualified plans to the extent excluded from the employee’s taxable income
• Other benefits which may be excluded from gross income (such as under cafeteria plans)
• The $1 million limitation is still reduced by the amount of any excess parachute payment for which a deduction is denied under IRC 280G
45
Changes to Executive Compensation under IRC 162(m) • Definition of covered employee
• Previously only applied to the following:
• Principal executive officer
• Next 3 highest compensated employees as reported in SEC filings
• Principal financial officer was excluded
• Redetermined each taxable year
• New definition:
• Includes both principal executive officer and principal financial officer
• Includes officers whose compensation must be disclosed to shareholders by virtue of being a top-3 highest paid officer
• Once a covered employee, always a covered employee
46
Changes to Executive Compensation under IRC 162(m) • Definition of publicly held corporation
• Previously included only corporations whose securities were required to be registered under Section 12 of the 1934 Act
• Now also includes any corporation which is required to file reports under Section 15(d) of the 1934 Act
47
Changes to Executive Compensation under IRC 162(m) • Transitional relief:
• New law does not apply to covered employees who have in place a written binding contract as to compensation as of November 2, 2017
• However, material modifications to such a written binding contract on or after this date will cause the new law to apply
48
Changes to Executive Compensation under IRC 162(m) • Pitfalls and issues to be aware of in M&A transactions:
• Taint of being “covered employee” under new rule follows employee of target who becomes employed by acquirer
• New rules may affect deductibility of payments to terminating employee who is a covered employee under new rules, such as severance and accrued PTO
• Discretionary bonuses may create material modification of written binding contract
• Beware valuation of equity or phantom equity which is not an incentive stock option under IRC 83 and 409A
• Beware issues with nonqualified plans under 409A and possible disqualification of target’s qualified plans under 401(a) in which covered employees participate
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