Capital Markets and M&A: 2025 Year-End Planning Guide for Private Companies
- HFM CPAs + Business Advisors
- 3 days ago
- 13 min read
The current capital markets environment remains marked by volatility, persistent inflationary pressure, and structurally higher interest rates. Companies are facing less predictable financing windows, with higher cost debt and volatile equity valuations. As a result, many issuers are increasingly turning to hybrid instruments such as convertibles, opportunistic equity raises, or converting maturing debt to equity when credit provides unfavorable refinancing options. With the current economic headwinds, companies are proactively recapitalizing to preserve flexibility ahead of potential market tightening.
The same economic factors are affecting the M&A market, which is beginning to rebound. Overall deal values increased over the summer despite fewer transactions, driven partially by digital transformation as companies seek to enhance capabilities.
Whether managing capital needs or engaging in strategic M&A activity, tax considerations should be part of the decision-making process. Several key issues and developments can impact strategy. Debt refinancing and hedging transactions can have important tax implications. Section 382 can restrict the value of tax attributes and may be particularly important with increasing deductions thanks to the OBBBA. The Tax Court has also issued an important ruling on termination fees, and the IRS has rescinded new reporting on certain types of transactions.
PLANNING FOR SECTION 382 LIMITATIONS
Section 382 limitations can significantly reduce the net present value of a corporation's net operating losses, Section 163(j) interest expense carryforwards, tax credit carryforwards, and Section 174 balances following an "ownership change." Section 382 limitations also may impact anticipated tax benefits when companies exit non-core businesses.
For purposes of Section 382, an ownership change occurs if there is a 50% shift in the corporation's 5% shareholder ownership within a rolling three-year period. An ownership change may occur as a result of cumulative transactions between a corporation and its shareholders, or it may come about because of an acquisition or merger. When an ownership change occurs, the analysis required to compute the applicable limitations is complex.
Regular, real-time monitoring of a company's Section 382 profile can identify opportunities to defer or avoid Section 382 ownership changes and associated tax attribute limitations. Opportunities may include, for example:
Sizing a stock issuance to keep the ownership shift below 50%.
Delaying an issuance or similar transaction to allow previous equity events to fall outside the rolling three-year window.
In certain circumstances, involving potential ownership shifts associated with large cash raises, redeeming non-participating 5% shareholders below 5% in conjunction with the capital raise.
Implementing strategies such as poison pills and share restrictions to avoid unanticipated ownership changes.
In some situations, triggering an ownership change during high equity valuations may be beneficial to limiting adverse consequences of Section 382 and may increase the company's flexibility to execute additional issuances or recapitalizations without triggering further ownership changes.
Planning Considerations
Timely, robust Section 382 analyses can provide strategic advantages in M&A transactions by:
Accurately pricing net operating losses, credits, and Section 174 balances into deal negotiations.
Identifying opportunities to unlock built-in gains in transactions that increase annual limitation capacity.
Avoiding post-transaction surprises by structuring ownership changes with Section 382 impacts in mind.
Companies with large unamortized Section 174 balances may face higher stakes. The OBBBA has increased the ambiguity of whether these costs constitute built-in-losses for Section 382 purposes, making proactive planning essential to mitigating the risk of unexpected limitations.
With rising costs and volatile valuations, Section 382 planning is vital, and tax departments cannot afford to treat potential Section 382 limitations as an afterthought. By integrating real-time ownership and tax attribute monitoring into strategic tax planning decisions, tax departments can help companies preserve and enhance the value of companies' tax attributes.
TAX COURT SUPPORTS DEDUCTION FOR TERMINATION FEE
The Tax Court held earlier this year in AbbVie, Inc. Subsidiaries v. Commissioner that an approximately $1.6 billion termination fee was properly deductible as an ordinary business expense, and should not be treated as a capital loss. The case has important implications for the treatment of termination and cancellation fees.
The case centered on a proposed merger between AbbVie and Shire to combine the two companies into a new holding company in Jersey. The transaction was subject to various conditions, including regulatory and shareholder approval.
The two parties entered into a "Cooperation Agreement" obligating both sides to be bound by the transaction and to perform certain actions to implement it. Significantly, the agreement required AbbVie to pay a break fee to Shire if AbbVie's board of directors failed to recommend the merger or shareholder approval was not obtained. After unfavorable tax guidance was released, AbbVie's board of directors withdrew its recommendation for the proposed merger and paid Shire the break fee.
AbbVie and the IRS disagreed on the treatment of the break fee. AbbVie argued the fee was deductible either as an ordinary and necessary expense paid or incurred during the tax year in carrying on any trade or business, or as a loss deductible under Section 165, which allows a deduction for any loss sustained during the tax year that is not compensated by insurance or otherwise. The IRS argued that the break fee was a capital loss under Section 1234A, a provision intended to prevent taxpayers from converting capital transactions into ordinary losses via contract terminations. Section 1234A provides that gain or loss attributable to the cancellation of "a right or obligation...with respect to property which is...a capital asset in the hands of the taxpayer" is itself treated as a capital gain or loss.
The Tax Court rejected the Service's position, finding that the agreement between AbbVie and Shire was not a right or obligation "with respect to property." The court's decision was based on a few key determinations. First, the agreement primarily focused on mutual commitments related to obtaining regulatory approval and the provision of corporate facilitative services rather than any direct transaction involving property rights. Second, the Tax Court interpreted the phrase "with respect to property" in Section 1234A to mean a right or obligation in exchange for property interests. The court found that the cooperation agreement included rights or obligations to perform services related to the property, but did not contain rights or obligations to transfer property. Accordingly, the court concluded that Section 1234A limits the scope of the provision to cases in which the taxpayer has a "right or obligation to exchange (i.e., to buy, sell, or otherwise transfer or receive) an interest in property."
Planning Considerations
The decision provides welcome and favorable guidance with respect to the tax treatment of termination fees, potentially limiting the scope of Section 1234A. Taxpayers should continue to monitor this area, however, as the IRS has appealed the decision to the Seventh Circuit. It should also be noted that the decision was very fact-specific and relied heavily on the determination that the obligations were largely service-oriented. The result underscores the importance of evaluating whether a contract obligates the parties to complete a transaction, or merely facilitates one. Companies should also note that notwithstanding the holding in AbbVie, a termination fee may not necessarily be currently deductible. Consideration must also be given to Reg. §1.263(a)-5, which generally requires termination fees to be capitalized if the payer is terminating the transaction to enter into another transaction.
IRS RESCINDS NEW REPORTING REQUIREMENTS FOR M&A TRANSACTIONS
The IRS has withdrawn and superseded guidance released just before former President Biden left office that covers the nonrecognition of gain or loss in corporate separations, incorporations, and reorganizations and updated reporting requirements for Section 355 transactions. The Biden-era guidance process started in May 2024 when the IRS updated its private letter ruling policy in Rev. Proc 2024-24 and outlined its views in Notice 2024-38. The IRS followed with two sets of proposed regulations in January 2025 (REG-112261-24 and REG-116085-23), which translated their views into formal guidance and imposed new multiyear reporting requirements.
The IRS has now withdrawn both sets of proposed regulations and issued a new revenue procedure (Rev. Proc. 2025-30) superseding the private letter ruling guidance in Rev. Proc. 2024-24. The maneuver essentially reverts to the rules in place under Rev. Proc. 2017-53 and Rev. Proc. 2018-53.
The move is welcome news for taxpayers, particularly those seeking private letter rulings. Although the regulations were still in proposed form, the IRS had been applying them to private letter ruling requests. The new rules (largely reverting to rules in place before Rev. Proc. 2024-24) will apply for any ruling requests postmarked or received after Sep. 29, 2025.
TREASURY TAX REVIEW
Treasury groups are facing unprecedented challenges from volatile market conditions. Uncertain interest rates, volatile credit markets, currency fluctuations, and strained commodity markets have all been affecting financing, investing, and cash management and have caused treasurers to reevaluate how and when to hedge various risks. These activities will generally have significant tax consequences and the need for tax departments to be involved in these decisions has never been greater. Companies should evaluate all treasury activities from a tax perspective on a regular basis.
DEBT REFINANCING TRANSACTIONS
Over the past year, many private companies have refinanced their existing debt to secure current interest rates, with the potential for rates to decrease in the future. Refinancing transactions that result in a "significant modification" of the debt under applicable regulations can have disparate tax consequences depending on the specific circumstances. Although the regulations provide relatively clear rules for determining when a modification is "significant," the application of these rules is highly fact-dependent and frequently requires relatively complex calculations.
Companies should review their debt modification transactions during the year to confirm their tax impact. Companies that are considering changes to existing credit facilities in the coming year should likewise assess whether the proposed change would amount to a significant modification and, if so, determine the tax implications of the modification.
Tax Treatment of Debt Modifications
The income tax treatment of debt refinancing transactions is highly fact-specific and requires careful analysis. Certain refinancing transactions may be treated as a taxable retirement of the existing (refinanced) debt, which may give rise to the ability to write off any unamortized debt issuance costs and original issue discount, the latter as "repurchase premium." However, in certain situations a refinancing transaction may also give rise to taxable ordinary income in the form of "cancellation of indebtedness income."
The tax consequences of a debt refinancing transaction hinge in part on whether the transaction results in a significant modification of the debt under rules set out in Reg. §1.1001-3, which results in a deemed retirement of the existing debt in exchange for a newly issued debt instrument.
When Is a Modification Significant?
As a threshold matter, a modification includes not only a change to the terms of an existing debt instrument but would also include an exchange of an old debt instrument for a new one or the retirement of an existing debt instrument using the proceeds of a new debt instrument. Stated differently — it is the substance, not the form, that governs whether debt has been modified for federal income tax purposes.
Whether a modification of a debt instrument constitutes a significant modification depends on the materiality of the changes. The regulations provide a general "economic significance" rule and several specific rules for testing whether a modification is significant. In practice, most debt modifications are covered by two specific rules governing changes in the yield to maturity of a debt instrument (the change in yield test) and deferrals of scheduled payments (the deferral test).
Yield test: Under the change in yield test, a modification is significant if the new yield of the modified debt instrument differs from the old yield of the unmodified debt instrument by more than 25 basis points (i.e., 1/4 of 1%) or 5% of the unmodified yield. Various changes, such as adjusting the interest rate, altering payment schedules, or paying modification fees, can impact the yield. It is not uncommon for a modification with only a minor (or no) change to the stated interest rate to result in a significant modification due to changes in the yield to maturity that result from the payment of modification fees or changes to the due dates for certain payments. This issue is often overlooked.
Deferral test: Under the deferral test, a modification is significant if it causes a material deferral of payments. While the test does not define "material deferral," it offers a safe harbor: a deferral is not significant if all payments are unconditionally made within the safe harbor period. This safe harbor period starts on the first deferred payment date and lasts for the lesser of five years or 50% of the original term (e.g., the deferral safe harbor for a five-year debt instrument would be two-and-a-half years).
In applying both the change in yield test and the deferral test, taxpayers are required to consider the cumulative effect of the current modification with any prior modifications (or, in the case of a change in yield, modifications occurring in the past five years). This cumulative rule is particularly noteworthy for taxpayers who routinely modify their debt (and often incur modification fees in connection with the modification), as the results of certain modifications may not be significant when viewed in isolation but may be significant when combined with prior modifications.
Tax Implications of Significant Debt Modifications
A significant modification results in the deemed retirement of the existing debt instrument in exchange for a newly issued debt instrument. The existing debt instrument will be deemed retired for an amount equal to the "issue price" of the newly issued debt instrument, together with any additional consideration paid to the lenders as consideration for the modification.
The issue price of a debt instrument depends on whether the debt instrument was issued for cash or property. If a significant amount (generally 10%) of the debt was issued for money, the issue price will be the cash purchase price. Otherwise, assuming the debt instrument is in excess of $100 million, the issue price will be its fair market value (or the fair market value of the property for which it was issued) if it is "publicly traded." In all other cases, the issue price of the debt instrument will generally be its stated principal amount.
If the issue price of the modified debt instrument (i.e., the repurchase price) is less than the tax-adjusted issue price of the old debt instrument, a borrower will incur cancellation of indebtedness income, which is generally taxed as ordinary income in the current tax year. If instead the repurchase price exceeds the adjusted issue price (this may occur when the old debt instrument had unamortized original issue discount or when the debt is publicly traded and has a fair market value in excess of its face amount), the borrower will incur repurchase premium. Repurchase premium is deductible as interest expense. Special rules apply to determine whether such repurchase premium is currently deductible or is instead amortized over the term of the newly issued debt instrument.
The retirement of an existing debt instrument may also give rise to the ability to deduct any unamortized debt issuance costs. As a general matter, the determination of whether any unamortized debt issuance costs should be written off or carried over and amortized over the term of the new debt instrument generally follows the same analysis as repurchase premium. Notably, debt issuance costs are deducted as ordinary business expenses under Section 162, and therefore are not subject to the limit on business interest expense deduction under Section 163(j).
Finally, a significant modification may give rise to additional tax implications that companies should consider, including the potential for foreign currency gain or loss and the need to "mark-to-market" existing tax hedging transactions.
TAX HEDGING IDENTIFICATION AND DOCUMENTATION
Most companies enter into hedging transactions to manage risk that arises in their business, such as interest rate, currency, and commodity price risk. These transactions are subject to tax hedging rules, and failure to follow the requirements under those rules could result in negative tax consequences. The tax hedging rules impose a same-day identification requirement with timing and character whipsaw rules that may apply if such transactions are not timely identified.
As part of year-end reviews and planning for next year, companies should review these rules and the sufficiency of their hedging identification and documentation processes so they can properly meet the requirements.
Tax Hedge Qualification & Character
To qualify as a tax hedge, the transaction must occur within the normal course of business and be used to manage interest rate, currency, or commodity price risk with respect to ordinary property or ordinary obligations (incurred or to be incurred) by the taxpayer. For this purpose, property is ordinary if a sale or exchange of the property could not produce capital gain or loss under any circumstances. Taxpayers may manage risk on a transaction-by-transaction basis or, alternatively, may manage aggregate risk (i.e., they may enter into one or more foreign currency contracts to manage aggregate foreign currency risk).
Gain or loss on a tax hedging transaction will be ordinary income or loss if the transaction is properly identified and documented in a timely manner.
Same-Day Identification Requirement
The tax hedging rules require that each tax hedging transaction be identified as such no later than the close of the day on which the hedge was entered into. The hedged item must be identified substantially contemporaneously with the tax hedging transaction, but in no case more than 35 days after the hedging transaction was entered into.
An identification must identify the item, items, or aggregate risk being hedged. Identification of an item being hedged involves identifying a transaction that creates risk and the type of risk that the transaction creates. This identification is made in (and retained as part of) the company's tax files and is not sent to the IRS. A GAAP (or IFRS) hedge identification will not satisfy the tax hedge identification requirement unless the taxpayer's books and records make clear that such identification is also being made for tax purposes. Additional regulatory guidance is provided for certain categories of hedging transactions, including hedges of debt issued (or to be issued) by the taxpayer, inventory hedges, and hedges of aggregate risk.
Taxpayers are given significant flexibility regarding the form of such identification. For companies that enter into tax hedging transactions infrequently, a same-day identification may be prepared and saved in the company's tax files. However, this approach is often challenging for taxpayers that enter into hedging transactions routinely (often on a daily basis). For taxpayers who enter into hedging transactions frequently, the same-day identification requirement can be satisfied through a tax hedging policy. A tax hedging policy will identify the types of transactions entered into to manage risk and the risk managed (and how such risk is managed) and will identify all transactions described in the policy as tax hedging transactions. If properly prepared, the tax hedging policy will serve as identification (for tax hedging purposes) of any transactions described in the policy.
Hedge Timing Rules
IRS regulations provide special tax accounting rules for tax hedging transactions known as the "hedge timing rules." The hedge timing rules provide a general requirement that the method of accounting used to account for hedging transactions must clearly reflect income by matching the recognition of income, deduction, gain, or loss on the hedging transaction to the recognition of income, deduction, gain, or loss on the hedged item. Special rules are provided for specific types of hedging transactions.
Failure to Identify — Timing & Character Whipsaws
Failure to properly identify a hedging transaction generally establishes that the transaction is not a tax hedging transaction. As a result, gain or loss on the hedging transaction is determined under general principles. However, the regulations provide a broad anti-abuse rule that will frequently treat any gains as ordinary, which may result in a character whipsaw in which losses are capital and any gains are ordinary income. The regulations provide an inadvertent-error exception, which, if applicable, may allow taxpayers to treat losses in some circumstances as ordinary.
A proper and timely hedge identification also prevents the application of certain loss deferral rules. One example is the tax "straddle" rules, which may defer losses (but not gains) on certain unidentified hedging transactions.
Planning Considerations
Given the volatility of commodity prices, interest rates, and foreign currency exchange rates, businesses are increasingly incentivized to rely on hedging activities to manage risk and reduce exposure to dramatic market movements. To prevent the character and timing mismatches previously discussed and properly report gains and losses from these hedging transactions, companies should carefully review their tax hedge identification policies or establish them if none exist. These are important planning considerations, and while the identification and documentation requirements are complex, failure to comply with these rules may result in significant adverse tax consequences.
Additional 2025 Year-End Tax Guides for Private Companies:
Questions?
Contact HFM CPAs for questions on how this change may affect your specific situation. Our team stays current with evolving tax and related legislation to help you navigate new opportunities and requirements.
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