The tax code received a major overhaul a few years ago with the passage of the law commonly known as the Tax Cuts and Jobs Act (TCJA). Passing the tax law turned into a highly partisan debate, and the result was approved mainly along party lines. With the upcoming federal election, the TCJA may once again become a political issue.
Democratic presidential nominee Joe Biden has indicated that, if elected, he would repeal or significantly modify certain key provisions enacted through the TCJA. There are several hurdles to clear before either candidate can implement further tax changes. Notably, for a Biden Presidency to change the tax code, the Democrats will very likely have come out of the election controlling a majority of the seats in the Senate. If Republicans maintain control of the Senate, for example, it would be unlikely that sweeping tax changes would garner enough votes to make into law, considering the Republican support for the TCJA several years ago. Conversely, any attempt by a Trump Presidency to change the tax code is likely to turn on the Republicans’ ability to gain control of the House and maintain control of the Senate.
But there are other scenarios worth noting. If Biden were to win the nomination but would be unable to pass sweeping tax reform early in his term, he may let many of the provisions of the TCJA expire as they are currently scheduled to at the end of 2025. President Trump, if re-elected, has indicated he wants to see many of the expiring tax reform changes (including tax rate cuts to the individual tax brackets) made permanent. A re-elected President Trump and a Republican majority in the House and Senate could result in some of these TCJA provisions becoming more fixed in the next term.
The following table provides a look at some of the key positional differences going into the federal election that would impact the private equity (PE) and venture capital (VC) industries.
Snapshot of the Candidates' Proposals and Their Impact on PE/VC
| ||Trump ||Biden |
|Individual Income Tax Considerations || || |
| ||TCJA rates become permanent ||Increase the top tax ordinary tax rate from 37% to 39.6% |
| ||Middle Class tax cut of 10% through reduction of individual tax rates ||Cap the value of itemized deductions at 28% and limit itemized deductions on income over $400,000 |
| ||Elimination of employee social security taxes ||Impose the 12.4% payroll tax on wages in excess of $400,000 |
|Qualified Dividend and Capital Gain Tax Considerations || || |
| ||Reduce long term capital gains maximum rate from 20% to 15% ||Increase capital gains rates to ordinary tax rate (39.6%) on income in excess of $1 million |
|Corporate Tax Considerations || || |
| ||Retain current rate (21%) ||Increase the rate to 28% |
| || ||Impose a minimum corporate tax of 15% of book income for corporations with book income greater than $100 million |
|Other Business Tax Considerations || || |
| ||Section 199A deductions to become permanent ||Phase out of the Section 199A deduction for related income in excess of $400,000 |
| ||100% bonus depreciation deduction to become permanent ||May consider a financial transactions tax supported by Harris and others |
| ||Retain current GILT rates (10.5%) ||Increase GILTI tax rate to 21% |
| ||Create additional incentive to invest in Opportunity Zones ||Reform Opportunity Zones |
| ||Eliminate carried interest tax preferences ||Eliminate carried interest tax preferences |
Potential Economic Consequences for Private Equity and Venture Capital Companies
When the TJCA took effect, PE and VC firms were looking at how to best leverage holding periods on investments, cash on hand, and how to most appropriately deduct interest. Those concerns will still be a factor if tides change, or as intentions are reconciled by dueling ideologies.
Biden’s proposed tax plan would most likely provide for reduced cash flows for PE/VC portfolio companies and potential targets. Cash flows of corporate entities may be impacted by an increased tax rate, a minimum income tax on book income and unchanged interest deduction limitations. With respect to pass-through entities, Biden has indicated that he would repeal or phase out the Section 199A deduction for taxpayers with income over $400,000. This would potentially require pass-through entities to consider additional tax distributions to its members to aid in their increased tax liability resulting from the lack of a Section 199A deduction. Overall, a change to the Section 199A deduction could potentially affect cash flow, which could have a correlative negative impact on portfolio and target valuations.
In addition to cash flow and valuation impact, the election may provide for changes to the treatment of carried interest. Generally, the TCJA requires that an applicable partnership interest and/or property sold by a partnership be held for a minimum of three years to gain long-term capital treatment (20% tax rate). Although the TCJA has increased the holding period required to receive long-term capital gain treatment related to carried interest, President Trump has indicated that he would like to eliminate the carried interest preferences. While Biden’s plan has not directly addressed carried interest, he has suggested that he is also in favor of eliminating tax preferences related to carried interests. Biden’s tax plan has more specifically addressed treatment of long-term capital gains, calling for long-term capital gains in excess of $1 million to be taxed at ordinary rates (39.6% in Biden’s plan). This would essentially tax the majority of all carried interests as ordinary income.
President Trump, on the other hand, has supported a possible capital gains tax holiday that would reduce the capital gains rate to 0% for a short time. He also has supported indexing basis for inflation to reduce ultimate capital gains upon sale.
It is difficult to forecast the overall implication of the Presidential election results, especially considering the number of House and Senate seats up for election. PE/VC firms and their investors should continue to monitor the election and the candidates’ campaigns for additional details on tax plans.
For more information, please contact Scott Costa of CBIZ and MHM New England’s Private Equity practice.
Published on October 27, 2020