U.S. Tax Reforms and Their Impact on Funding

29 January 2025

How U.S. Tax Reforms Influence Investment and Business Growth

Tax policies in the United States have a profound impact on businesses, investors, and economic growth. Over the years, U.S. tax reforms have aimed to balance revenue generation with incentives that encourage investment, innovation, and job creation. The impact of these reforms extends to startups, corporations, and venture capitalists, influencing funding strategies across multiple industries. This article explores the key tax reforms and their effects on investment funding in the U.S.

1. The 2017 Tax Cuts and Jobs Act (TCJA) and Its Impact on Funding

One of the most significant tax reforms in recent history, the Tax Cuts and Jobs Act (TCJA) of 2017, introduced several changes that affected corporate and individual taxation:

Corporate Tax Rate Reduction: The TCJA reduced the corporate tax rate from 35% to 21%, making the U.S. more competitive globally and encouraging businesses to reinvest profits into growth and expansion.
Pass-Through Deduction for Small Businesses: Small businesses structured as LLCs, partnerships, and S corporations benefited from a 20% deduction on qualified business income, increasing cash flow for startups and small enterprises.
Increased Bonus Depreciation: Businesses could immediately deduct 100% of the cost of qualified capital expenditures, encouraging investment in new equipment, infrastructure, and technology.

Impact on Funding: These tax reductions provided more liquidity for businesses, allowing them to allocate additional resources toward R&D, hiring, and venture funding. However, concerns remain about the long-term effects on federal deficits and future tax policies.

2. Venture Capital and Startup Funding Under U.S. Tax Reforms

Venture capital firms and startups are highly sensitive to tax policies that influence investment incentives and exit strategies. Key tax-related factors affecting startup funding include:

Capital Gains Tax Implications: Lower corporate tax rates and tax incentives for long-term capital gains encourage venture capitalists to invest in high-growth startups.
Qualified Small Business Stock (QSBS) Exemption: Section 1202 of the Internal Revenue Code allows investors in certain small businesses to exclude up to 100% of capital gains (up to $10 million) from federal taxes if they hold stock for five years. This has been a significant incentive for angel investors and early-stage venture funds.
R&D Tax Credits: Startups focusing on technology and innovation benefit from federal R&D tax credits, reducing their taxable income and freeing up more funds for expansion.

Impact on Funding: These policies have made the U.S. an attractive destination for venture capital investment. However, potential future tax increases or modifications could shift investor behavior.

3. Tax Policies Affecting Private Equity and Institutional Investors

Private equity firms play a crucial role in funding businesses, acquisitions, and expansions. Several tax reforms impact their strategies:

Carried Interest Taxation: The TCJA increased the holding period for carried interest from one year to three years to qualify for lower long-term capital gains tax rates. This policy affected hedge funds and private equity firms, requiring longer investment horizons.
Limitations on Interest Deductions: Section 163(j) of the TCJA placed caps on interest expense deductions for businesses with high debt financing, affecting leveraged buyouts and corporate mergers.
Impact of Global Intangible Low-Taxed Income (GILTI) Tax: U.S. multinational companies faced new taxation rules on foreign earnings, impacting global investment strategies.

Impact on Funding: While private equity remains a key player in funding U.S. businesses, regulatory uncertainty and potential future tax hikes could influence investment decisions.

4. Tax Policy and Economic Stimulus Measures

In response to economic challenges, the U.S. government has introduced temporary tax relief measures to support businesses and encourage investment. Examples include:

Paycheck Protection Program (PPP) and Tax Deductibility: The COVID-19 relief program allowed businesses to access forgivable loans while ensuring tax-deductibility of related expenses.
Employee Retention Tax Credit (ERTC): Aimed at keeping businesses afloat during downturns, this credit helped maintain payroll and business continuity.
Proposed Corporate Tax Increases: Recent discussions in Congress suggest potential corporate tax rate increases (from 21% to 28%) and changes to capital gains taxation, raising concerns among investors and business owners.

Impact on Funding: Temporary tax incentives have helped businesses sustain operations, but long-term uncertainty about tax hikes could affect future funding flows.

5. Future Tax Reforms and Their Implications on Funding

As tax policies continue to evolve, businesses and investors must stay informed about potential changes that could impact funding strategies:

Proposed Wealth Tax on High-Net-Worth Individuals: Discussions around a wealth tax on billionaires could influence capital allocation and investment in private markets.
Potential Increases in Capital Gains Tax: Raising capital gains tax rates could lead to changes in venture capital and private equity exit strategies.
Modifications to Corporate Tax Rates: If corporate tax rates increase, businesses may adjust funding strategies, focusing more on debt financing than equity.
Sustainability and Green Investment Tax Incentives: Future tax reforms may include incentives for clean energy investments, encouraging funding in sustainable technologies and industries