Jim Birge & Brent Mosby: Will tax uncertainty slow the merger frenzy?

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The mergers-and-acquisitions market has been on a torrential pace in 2021. The total value of deals announced to date has already surpassed the full-year total for 2020, both nationwide and in Indiana.

Indiana deals announced to date total $2.078 billion, versus $2.063 billion for all of 2020, according to PitchBook Data Inc. A variety of factors—including low interest rates, lofty valuations and the general economic recovery—have driven this growth.

In addition, there is the widely held view that capital-gains tax rates will be going up, and that, too, has spurred increased M&A activity. We have seen this dynamic in the past, most recently in 2012 when the top capital-gains tax rate was poised to rise from 15% to 20%.

However, this time around, there is a catch—the tax increase might apply retroactively, potentially eliminating the tax benefit of getting a deal done by year-end.

President Biden has made no secret of his intention to raise taxes, and in April he provided details of what his administration deemed the American Families Plan, a $1.8 trillion proposal for expanded social programs. To help pay for the American Families Plan, Biden proposed taxing long-term capital gains as ordinary income for taxpayers with taxable income above $1 million and raising the top marginal income tax rate to 39.6%.

Subsequently, the House of Representatives and Senate passed a $3.5 trillion budget resolution and assigned the House Ways and Means Committee and the Senate Finance Committee the task of finding enough tax increases to cover the total cost.

On Sept. 15, the House Ways and Means Committee recommended several tax reforms, including an increase in the top long-term capital gains rate to 25%, from 20%. The Senate is expected to weigh in soon with its own tax proposals, and differences between the proposals will have to be resolved before final legislation can be put to a vote.

The tax proposals from the Biden administration and the House differ in several respects, but one similarity is their retroactive nature.

Under the president’s proposal, the capital-gains hike would date back to April, when the American Families Plan was introduced. Under the House’s proposal, the 25% rate would be effective for long-term capital gains recognized after Sept.13, but there is an exception for gains recognized after Sept. 13 resulting from a transaction that occurs pursuant to a definitive agreement entered into on or before (and not materially modified after) Sept. 13.

It is rare for a tax change of this magnitude to apply retroactively, but there is legal precedent, as the U.S. Supreme Court has upheld retroactive tax increases in the past. Political support for retroactivity, however, might be another story. The Democrats have slim majorities in the House and Senate, and the potential fallout from a retroactive tax increase might be too much for some moderate Senate Democrats.

Predicting what will come out of Washington is generally a fool’s errand, yet it seems safe to assume that Biden’s effort to marry capital gains and ordinary income tax rates will be unsuccessful. Similarly, given the current political climate, the retroactive nature of the House’s proposed tax increases might not survive reconciliation in the Senate.

However, on the off chance that the House’s proposal wins the day, those lucky enough to have a signed definitive agreement before Sept. 13 should proceed with caution before making any material changes.

For anyone else trying to get a deal done under the current tax regime, higher capital-gains tax rates are likely on the way—maybe as of Sept. 13, maybe as of a different date, but almost certainly by Jan. 1—so, best to press on and get your deal done before the clock strikes midnight on Dec. 31.•


Jim Birge is a partner at Faegre Drinker in Indianapolis, and Brent Mosby is a counsel there. Both are members of the firm’s corporate practice group.

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