The Tax Cuts and Jobs Act was signed into law on December 22, 2017 by President Trump. In addition to its effect on corporate and individual taxes, the act will impact valuations of businesses. This article briefly discusses several of the act’s provisions, and their impact on the value of your business, including: changes to the corporate tax rate, changes to depreciation of qualified property and the limitations on the tax deductibility of interest expense. Specific facts and circumstances of your business must be considered in detail prior to making any planning decisions.
Changes to the corporate tax rate: The permanent reduction of the federal tax rate for C corporations from 35 percent to 21 percent will, all things being equal, increase the value of a business. After-tax cash flows will be higher but partially offset by an increased after-tax cost of debt.
Qualified Business Income: The act contains a provision whereby certain S corporation shareholders, LLC members and partners can deduct 20 percent of their qualified business income to arrive at their taxable income. This provision contains a series of overlapping limitations, qualifications and definitional provisions that are complex even for the most sophisticated professional. This deduction expires after 2025, when tax-rates revert to their pre-2018 levels.
Basically, a taxpayer of a service-based business in the fields of health, accounting, law and certain other professions can take advantage of the 20 percent deduction, if the taxpayer’s taxable income is less than $315,000 (if married) or $157,500 (if single). The deduction phases out as taxable income increases, so there is no deduction for a taxpayer whose taxable income exceeds $415,000 (if married) or $205,500 (if single). What does this mean for your buy-sell?
If the business is a non-service business (again, a pass through entity), the taxpayer can utilize the benefit from the 20 percent deduction without regard to their taxable income levels.
This description only scratches the surface of the qualified business income rules. Remember that this provision can have a material effect on an entity’s taxes and value.
Changes to Depreciation of Qualified Property: The purchase price for qualified property, both new and used assets, will be eligible for 100 percent bonus depreciation through December 22, 2022. This means qualified assets purchased will be immediately deductible. After December 22, 2022, the bonus depreciation percentage gradually declines for purchases in each year through 2026.
Limitations on the tax deductibility of Interest Expense: Another key provision of the act to consider is the broad limitation on the deductibility of business interest expense paid or accrued. The new rule does not allow interest deductions to the extent that net interest expense (interest expense minus interest income) exceeds an adjusted earnings-based threshold. This business interest expense limitation will not apply to businesses with average annual gross receipts of $25 million or less.
Changes to estate, gift and individual tax provisions: Other tax law changes that will likely impact you as you plan for the future include:
- The lifetime exemption amount was doubled to $11,180,000 per person in 2018. This provision sunsets December 31, 2025
- The annual exclusion for gifts increased to $15,000, up from $14,000, for the tax year 2017
- State and Local Tax (SALT) deduction: As mentioned above, taxpayers who itemize can deduct their state individual income, sales and property taxes up to a new limit of $10,000 starting in 2018. (However, C corporations can continue to deduct its state and local taxes.)
- The limited SALT deduction offsets the reduction in the top individual federal tax rate from 39.6 percent to 37 percent
- Changes were made to both the standard deduction and personal exemption, as shown in the table below. The significant, temporary increase in the standard deduction is intended to compensate for the loss of personal exemptions.
||basic standard deduction (2017)
||Basic standard deduction (2018)
|Single and Married filing separately
||Single and Married filing separately
|Married Filing Jointly
||Married Filing Jointly
|Head of Household
||Head of Household
These new tax provisions are complex and will have significant ramifications on the value of closely-held businesses. Be sure to consult a valuation and tax professional who can perform a diligent analysis and consider the potential impact of the provisions of the act mentioned above, along with those provisions not discussed. The significant changes with the Act could have material and lasting changes on the value of your business.