m&a and tax reform: new deal structure...

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

[email protected]

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preference items is permanently repealed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


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


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


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

Tax Cuts and Jobs Act Impact on Sellers

Russell A. Daniel

[email protected]

March 15, 2018

© 2017 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd

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.

13


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

14


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)

15


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

16


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

%

17


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

18


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

19


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

20


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

21


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


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


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.

24


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


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.

26


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.

27


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.

28


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.

29

TAX LAW CHANGES: SALE OF U.S.

PARTNERSHIP INTEREST BY NON-U.S.

PERSON Presented by:

Griffin H. Bridgers

Hutchins & Associates LLC

Denver, CO

[email protected]

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


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)


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


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


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


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):


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


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

[email protected]

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

49

m&a and tax reform: new deal structure...

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