What Happens If Congress Eliminates the Corporate Interest Tax Deduction?

Once again, the U.S. is rife with political uncertainty about taxation – a condition the business community abhors.  This political season we are hearing many ideas and proposals from both parties that could have potentially deleterious effects on business conditions (thus ultimately a negative impact on job growth and personal incomes).  

If your company is contemplating a major transaction, such as a sale, or an acquisition, you should consider accelerating the timeline, to “lock in” a more predictable outcome, rather than pushing it out into an uncertain future.

The long-standing allowance for companies to deduct the interest that they pay on debt is coming under the microscope.  Would eliminating it effectively raise tax revenues, or would eliminating it result in such a cost hit to American companies that potential tax revenue gains would be offset by tax revenue declines elsewhere?

That is a critical question, and the pro forma analysis would be not only highly complex but speculative – and highly dependent upon other simultaneous changes, such as perhaps a decline in the overall corporate tax rate.  

Among the aspects to consider is the hit to corporate valuations, which are highly dependent upon the cost of capital to the company and the rate of its growth.  Immediately, it’s apparent that the cost of debt capital would rise if companies lose the ability to write off the interest, and growth would slow, as there would be less incentive to invest in growth.  
Following this logical progression, publicly held stock prices would decline, thus various retirement pension plans and personal assets would decline in value, too.  Concurrently, the value of privately held companies – by far the greatest source of personal wealth generation in the country – would decline, too.

If it sounds ugly, that’s because it is.

An organization to which I belong, the Association for Corporate Growth, just released the result of a study which quantified the cost of cutting the deduction based on likely changes that would follow in cost of capital and future growth rates.  ACG conducted the study with RGL Forensics, perhaps the world’s largest accounting firm dealing exclusively in forensic accounting.  It concluded:

“U.S. middle-market companies will lose more than $1 trillion—that’s trillion with a “t”—in equity value if the Corporate Interest Tax deduction is eliminated.
Cutting the CIT deduction without offsetting benefits would lead to a 6.3 percent drop in equity value for U.S. middle-market enterprises—those with between $10 million and $1 billion in annual revenue (and which provide 48 million jobs). That equates to more than $1 trillion. With a 0.5 percent decrease in growth, equity value would decline by 15.3 percent, or about $2.5 trillion.”

Conclusion

According to ACG, “this is one issue where Clinton and Trump would seem to agree, because of their general statements in favor of cutting itemized deductions. It’s not clear if either candidate has directly addressed the Corporate Interest Tax deduction, however.”

Obviously, nobody knows the outcome of the upcoming elections or future tax decisions Congress will make.  While it’s possible that tax laws supporting a sale/merger/acquisition transaction will become more favorable, it’s certainly possible that the opposite will occur.  I suggest that you take the uncertainty into account when planning such major transactions, as accelerating the timeline into the “known” outcome may be preferable to passively awaiting the “unknowns” to resolve.

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McGavock Dickinson (Dick) Bransford is a Managing Director in San Francisco with Mid-Market Securities, LLC, an investment bank headquartered at 11 East 44th Street, 19th Floor, New York, New York 10017. Member FINRA/SIPC.  He can be contacted at (415) 294-0002 or mdb @ mid-marketsecurities.com.

Disclaimer: This article provides general information, and is not intended to constitute, and should not be construed as, legal, tax, accounting or business advice, nor does it constitute an offer to sell or to purchase securities. Rather, it is summary compilation of timely issues confronting your industry and as such does not purport to be a full recitation of the matters presented.  Prior to acting upon any information set forth in this article or related to this article, you should consult independent counsel and/or more detail contained in the Source Information. The article reflects the opinion of the writer, and does not necessarily reflect the opinions of Mid-Market Securities, LLC, or its affiliates.  IRS Circular 230 Disclosure: In order to comply with requirements imposed by the Internal Revenue Service, we inform you that any U.S. tax discussion contained in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.