Uncertainty Adds Urgency: Potential for Tax Increases Impacts M&A Transactions

For over a decade, total deal value and deal counts have steadily risen due to increased fund raising from private equity, higher valuations and a larger population of baby boomers looking to transition into retirement. Despite the COVID-19 pandemic and a severe drop-off in deal activity during the second quarter of 2020, private equity deal activity in the U.S. for all of 2020 still matched the record-setting activity of 2018 and 2019. For 2021, it’s shaping up to be another record-setting year for transaction activity that may not soon be matched. Through the first half of 2021, U.S. private equity deal activity has already surpassed nearly two-thirds of the deal value we saw in all of 2020 with Q2 registering the second-highest level of deal activity in a decade.

The largest single component of the 2021 rush to exit has been the Biden tax proposals and specifically, the proposed increase in the capital gains tax rate. Under the Tax Cuts and Jobs Act of 2017, the current highest capital gains tax rate stands at 20% and the top marginal tax rate on ordinary income stands at 37%. On May 28^th, the Treasury Department released its Green Book, a general explanation of tax proposals included in the Biden administration’s fiscal year 2022 budget submission to Congress. The document provides more details regarding the Administration’s tax proposals that had been previewed in the American Jobs Plan and the American Families Plan introduced by Biden. The proposals would raise the top marginal income tax rate to 39.6%. For those with taxable income above $1 million, the proposals would also tax capital gains as ordinary income raising the tax rate from 20% to 39.6%. When you factor in the proposal to subject all sources of investment income above $400,000 to the Net Investment Income Tax (NIIT) of 3.8%, including active pass-through income currently exempt from the NIIT, the overall federal tax on gains from the sale of a business could rise from 20% to 43.4%. Facing the prospect of more than double the tax on the same transaction, business owners have made a mad dash to exit through the first half of 2021 with Q3 and Q4 shaping up to set new records.

For business owners looking to exit before year-end and avoid any looming tax increases, their business needs to be well positioned and ready to expedite the transaction timeline. Having a sell-side due diligence and quality of earnings report prepared can go a long way to cut down and condense the buyer due diligence and closing timeline. Working with a team of experienced advisors including investment bankers, attorneys and accountants can greatly increase the prospect of a successful and timely transaction especially amid the mass exodus that has increased supply for buyers to select from.

Whether you are looking to complete a transaction in the next four months or in the next four years, BMSS Advisors & CPAs’ team of transaction advisory professionals is ready to assist you and your business. We offer both buy and sell-side financial due diligence and quality of earnings, tax due diligence, and IT due diligence and security assessments. We can also work with your team of legal and investment advisors to optimize and model the tax structure of a transaction along with your broader financial situation, assist with buyer integration, and support you with other needs arising from the transaction. For owners who are not quite ready to consider an exit –even in the face of increased taxes– now may be the time to get organized and prepared for any future transaction. Preparing for a transaction while in the middle of one is certainly not ideal.

BMSS can help you maximize your future transaction value and readiness creating real value for any business. For more information, please contact our Transaction Advisory Practice Leader Mark Underhill at (205) 271-5454 or munderhill@bmss.com.