Potential 2022 Capital Gains Hike Boosting Hospice M&A

The Biden administration’s proposal to raise the tax rate on long-term capital gains to 43.4%, up from the current 23.8%, is likely accelerating 2021 hospice acquisitions as companies try to seal their deals before the hike takes effect. The Internal Revenue Service (IRS) applies capital gains taxes to the proceeds generated by selling investments. 

Historically, capital gains tax rates have been lower than those for income on wages and salaries. “Long-term” capital gains are those that come from investments sold after being held for longer than one year. President Biden has indicated the higher tax revenue would be allocated to fund social programs and infrastructure improvements.

Sellers fretting over the tax, coupled with demographic tailwinds and pandemic-related factors, are propelling the already robust hospice M&A market.

Advertisement

“Sellers’ anticipation of an increase in the capital gains tax rate is something that is undoubtedly the biggest driver of the current market,” Cory Mertz, managing partner with the M&A advisory firm Mertz Taggart said. “I expect we’re going to see this kind of velocity and perhaps acceleration as we close out 2021, barring anything unforeseen. This is setting up to be another record year for the sector.”

If enacted, the tax increase would become effective Jan. 1, 2022 and would significantly impact a wide range of investment income, including hospice transactions. According to Merz Taggart, under current rates a $10 million deal would bring in $7.62 million after taxes. If Biden’s proposal comes to fruition, an asset’s sale price would have to reach $13.6 million to net the same $7.63 million. 

Biden floated the tax proposal in an April 28 address to Congress. Legislative action would be necessary to enact the proposal, which to date has not occurred. Republicans have indicated that they intend to fight the move, which would roll back Trump-era tax cuts.

Advertisement

“It’s going to cut down on investment and cause unemployment,” Sen. Chuck Grassley (R-Iowa) said. “If it ain’t broke, don’t fix it.”

Hospice M&A has been thriving this year even in the face of skyrocketing valuations. During the 12-month period ending May 15, hospice and home health multiples reached 26.2x compared to 16.1x for the overall health care sector, according to a recent report from PricewaterhouseCoopers.

Mertz Taggart reported that 16 hospice transactions took place in the second quarter of 2021 alone. This activity is unlikely to slow through the remainder of the year. Among the driving forces behind this continued acceleration include demographic tailwinds, rising demand and the opportunity for substantial return on investment for private equity buyers that plan to sell off those assets within a few years.

One factor that can’t be ignored is that hospices suffered financially due to COVID-19.

About 60% of hospices anticipated drops in annual revenues stemming from the pandemic, according to May 2020 research by the National Association for Home Care & Hospice. Nearly 30% indicated that they expected revenue declines of 15% or more during calendar year 2020. Hospices saw increased demand for personal protective equipment (PPE) and other scarce resources even as prices of those products skyrocketed.

Many providers also saw reduced referrals and admissions from hospitals, skilled nursing facilities and senior living operators due to pandemic-related disruption.

While many providers are seeing signs of recovery as those issues start to subside due to vaccinations and falling infection rates, for some hospices the damage was already done. A contingent of smaller organizations that tend to see slight margins were unable to take these punches. This moved many of them to sell their businesses to larger companies or private equity firms hungry for a hospice.

“M&A activity ticked back up in a major way in the last quarter, as was expected,” Mertz said. “Unfortunately, a lot of agency owners are burned out and thus looking to sell. The pandemic has undoubtedly taken its toll.”

Companies featured in this article: