March 29, 2019

Tax Reform for Business Lawyers - One Year Later

This presentation will focus on the 2017 Tax Reform, also known as the Tax Cuts and Jobs Act ("TCJA"), and issues business lawyers should be aware of when structuring acquisitions.

The TCJA introduced new aspects to entity choices when setting up an acquisition structure. Whether an acquisition is structured through an individual, an S-Corp or a partnership has big implications on the taxation. The TCJA brought many changes to the pass through taxation and the use of subchapter S corporations.

The tax reform also changed the thinking of how to finance an acquisition. In the past, within the limitation of re-characterization of debt into equity, in many instance debt was the financing option that was preferred over equity financing. However, the TCJA forces US companies to rethink this approach. Under the new law, financing the purchase through debt can be particularly challenging given the new limitation on interest deductibility. Based on the amended provisions of the Internal Revenue Code, interest expenses may only be deducted up to the net interest income plus 30% of the adjusted taxable income, which is basically the same as EBITDA. As of 2021, this limit will be further tightened by replacing the EBITDA limit with 30% of EBIT. Any interest that was not deductible in any given year, may be carried forward and utilized in later years. The limitation applies to debt by related and unrelated parties alike and generally makes additional modelling necessary. While this limitation of the interest deductibility is a tax provision many countries have implemented recently and which the European Union forced on their Member States by way of Directive, most other countries draw a distinction between unrelated party debt, which is not subject to the limitation and related party debt, which is subject to the new rules. The US law does not differentiate, which makes finding the most beneficial financing structure quite an exercise.