In Part 3 of our article Tax reform’s impact on private equity and M&A markets, we recap the net operating loss limitations brought about by the Tax Cuts and Jobs Act and how they could impact M&A market activity, buyers, sellers and the private equity industry as a whole.
The Tax Cuts and Jobs Act (TCJA) has limited the amount of net operating loss (NOL) that can be utilized in a given tax year while allowing for an indefinite carryforward. Starting in 2018, businesses can only use carryforwards up to 80 percent of taxable income, down from the 100 percent previously allowed. NOLs not utilized in the year generated may now be carried forward indefinitely, but the TCJA has eliminated the carryback of NOLs. This limitation could change deal structures when it comes to realizing the value of the tax benefits available to the buyer post-closing, as the buyer’s time frame for realizing these benefits may be extended. Note that net operating losses generated in tax years beginning prior to Jan. 1, 2018, are not subject to the 80 percent limitation; therefore, the benefits of such loss carryforwards will need to be tracked separately and may be more valuable.
The changes related to NOLs have had mixed influences on M&A market activity. This will likely not affect deal activity, but dealmakers will need to understand the change in structure and value of the NOL benefits.
During negotiations, buyers must be aware of the decreased value of NOLs, taking into consideration the lower tax rate at which the NOL benefit will be realized and the new 80 percent limitation. These changes, along with section 382 limitations on the use of acquired NOLs, have an overall effect of reducing the relative value of the acquired attribute.
Sellers may need to get creative to sell the value of their NOLs or consider structure alternatives. Considerations such as asset sales, where the seller utilizes the historical NOL to offset gain on the sale of assets, essentially refreshes the value of the NOL in the form of additional asset basis for the buyer. Modeling of alternatives by the seller ahead of the transaction will be key to providing alternatives to maximize value.
With the elimination of NOL carrybacks, the tax benefit of transaction related costs that generate NOLs in the tax year of a transaction (such as change of control payments) are not immediately realized and can no longer be utilized to offset required funding of an acquisition. This, along with the factors noted above, has resulted in a reduction in the relative value of acquired NOLs.