Navigating 2025 tax policy uncertainty in mergers and acquisitions

Tax policy can have a profound impact on the M&A market.

Two questions to ask

• How is TCJA uncertainty impacting M&A?
• What steps can buyers take in this volatile environment? 

In the complex and ever-evolving landscape of US tax law, the outcome of the elections and the uncertainty whether the Tax Cuts and Jobs Act (TCJA) will be extended in whole or in part introduce significant uncertainty over future tax policies and, by extension, the mergers and acquisitions (M&A) market. The interplay between these issues and M&A activity can be profound, influencing corporate strategies, investor sentiment and US economic growth. Specifically, proposed changes to the US corporate tax rate and capital gains rates, if enacted, along with modifications to key tax provisions such as Sections 168(k), 174, and 163(j) that have already taken effect, will impact the M&A market.

The cloud of uncertainty

The ambiguity surrounding potential changes to tax law and policy has become a significant concern for stakeholders in the M&A market. The uncertainty is not just about which policies will change, but also the extent and direction of those changes. This unpredictability makes it challenging for businesses to plan for the future, particularly when executing M&A transactions, where tax considerations can play a key role in deal structuring and valuation.

Impact of specific tax law changes

Corporate tax rate

An increase in the US corporate tax rate could significantly impact M&A activity. In anticipation of potential rate increases, taxpayers may seek to accelerate transactions while the rate is lower, leading to increased M&A activity ahead of a future rate change. 

A US corporate tax rate increase would also raise the value to a buyer of obtaining an asset basis step up as part of an acquisition. The increased value of a step up could justify an increase in the overall purchase price paid to a seller in order to compensate them for any additional tax cost of an asset sale (as compared to a stock sale). 

Furthermore, increases to the US tax corporate rate would enhance the relative attractiveness of tax-free disposition transactions, such as spin-offs, as compared to taxable sales. 

Capital gains rates

Changes to individual capital gains rates could also influence M&A dynamics. A change to the capital gains rate would affect the net proceeds sellers receive from transactions, possibly leading to higher asking prices or a decrease in the willingness to sell. This could result in a slowdown in deal flow, particularly for transactions involving closely held or family-owned businesses. A change to capital gains rate could potentially make tax-deferred M&A structures, such as a Section 368 reorganization, more attractive to sellers.

Modifications to Sections 168(k), 174, and 163(j)

The TCJA significantly altered Sections 168(k), 174, and 163(j), which has had an impact on M&A activity. Section 168(k) allows for immediate expensing on the acquisition of eligible property, with the amount of expensing phasing down through the end of 2025. If Section 168(k) immediate expensing were brought back as part of future tax law changes, this would likely incentivize asset acquisitions. 

Section 174 now requires capitalization of R&D costs, increasing short-term tax obligations and potentially affecting cash flow and valuations. Congress may revisit this to help encourage domestic R&D investment, which could positively impact M&A in R&D-intensive sectors.

Section 163(j) limits business interest expense deductions, affecting leveraged transactions. Any relaxation of this limit could make debt financing more attractive, potentially increasing leveraged M&A activity.

Conclusion

The current tax policy landscape has introduced a significant level of uncertainty into the M&A market, prompting stakeholders to adopt various approaches to help reduce potential risks. While it remains to be seen how Congress and the Administration will address the numerous tax provisions in play, it is clear that these decisions will have far-reaching implications for tax law and policy, and consequently, for M&A activity. As the market navigates this uncertain terrain, flexibility and adaptability will be key to benefiting from opportunities and reducing potential drawbacks.