Impact of the New Tax Law on Funds, Deal Structure, and Your Investors

Impact of the New Tax Law on Funds, Deal Structure, and Your Investors

Below are highlights from a well-attended April 3, IVCA tax breakfast presented by Plante Moran. The speakers were Mark Blumenthal, Partner, National Family Office Services and Co-Leader Chicago Investment Fund Services; Kurt Piwko, Partner, National Tax Office; Matt Petrucci, Partner, Leader National Transactional Advisory Services; and Stephen Eckert, Manager, National Tax Office. 

The Tax Cuts and Jobs Act, generally effective January 1, 2018, has dramatically changed the Tax Code and the historical tax planning assumptions and techniques used for many investment funds, portfolio companies and investors. These new rules will influence the after-tax decision of whether to use C-corporations or LLCs for the fund’s management and portfolio companies. Brand new cash flow and tax models are required to evaluate the differences between using a C-corporation (21% tax rate) and LLCs (individual tax rate of up to 37%) and the ultimate tax difference for your investors on sale. The single level of tax when selling a partnership or C-corporation stock is still a significant factor, as compared to double taxation when selling C-corporation assets and liquidating the corporation. Adding to the deal structure equation for some individual investors is the new 20% qualified business income deduction (resulting in an effective 29.6% top individual tax rate) and the $500,000 business loss limitation.

Good news, most expenses relating to your annual investor meeting are still 100% deductible. Bad news, your fund level management fees that were previously portfolio expenses for your individual investors are now not deductible.

Decisions regarding the use of debt versus equity for portfolio companies should take into account the impact of the new limitation on business interest expense. While this limitation may increase tax liabilities of highly leveraged companies, the use of significant debt may still provide the best after-tax returns. The new 100% bonus depreciation for both new and used equipment will increase a portfolio company buyer’s desire for asset acquisitions and make C-corporation stock purchases less attractive in certain situations. Accordingly, there may be an increased use of tax gross-up payments to compensate a seller for selling assets instead of C-corporation stock. Finally, the new carried interest rules may create challenges for the unwary, but long-term capital gain treatment can still be the result for most fund sponsors with careful tax planning.

IVCA thanks the event sponsor: