Leveraged Buyouts and Tax Incentives

Abstract

We investigate the tax incentives for leveraged buyouts by measuring the change in taxes paid by a firm due to a buyout. Estimates are made of the change in taxes paid by 23 of the largest leveraged buyouts in 1988, 1989 and 1990 under three different tax structures and use a pre-TRA '86 tax structure as a comparison point. A significant portion of buyout premiums still appear to be caused by a reduction in taxes. But, on average, after the Tax Reform Act, less than half the premium can be attributed to the reduction in taxes. Further, the Tax Reform Act levy of a capital gains tax on the target firm in the case of a Section 338 election (step-up of the assets basis) appears to have effectively eliminated the step-up option, unless there is a method of avoiding this capital gains tax as the taxation literature hints.