Many business owners are considering the impact of tax reform on their organizations. Deciding what changes to make—if any—can present challenges. Common questions revolve around choice of business entity and the 20% pass-through deduction. As these questions come up or as business owners start planning for tax season, they should consult with their advisor about possible tax planning moves only after considering long-term planning issues such as their plans for succession. Short-term and long-term tax impact of any changes need to be calculated, and so we’ve put together a few points to consider:
Timing of Business Succession
Part of the Tax Reform Act included a reduced tax rate for multinational corporations to repatriate foreign sourced income. Corporations are taking advantage of this opportunity by bringing cash back to the United States, which will partially be used to grow through acquisition of middle market businesses.
Additionally, lower corporate and individual tax rates that were a result of the tax reform act will impact the timing of when business owners might sell their business. As we know, tax rates can change, which would influence when you can get the most return for your company.
Increased Depreciation Deduction for New
and Used Assets
For transactions structured as an asset sale, where the business assets are sold to the buyer, there is an opportunity to increase the depreciation write-off for all qualifying property. Qualified personal property includes certain furniture, fixtures and equipment, and buyer can deduct 100 percent of the cost in the first year, under the enhanced bonus depreciation rules (this 100 percent deduction starts to phase out in 2023 by 20 percent per year until 2026). For leasehold improvements that are considered qualified improvement property, 100 percent of the cost can also be written off in the year these assets are placed in service. This immediate write-off could create a tax loss for the acquired business that could offset other taxable income, or, simply reduce the tax burden overall.
Business Interest Expense Limitations
A new concept was introduced under the tax reform act that limits interest expense deductibility. It is widely believed that this was put in place to discourage excessive debt financing by businesses. Businesses with less than $25 million of average gross receipts over the last three years are not subject to this limitation. Additionally, certain industries can elect out of this limitation, including construction, real estate, electing farming business and public utilities, as well as management and brokerage businesses. The general limitation starting in 2018, is 30 percent of adjusted taxable income. The interest limitation also excludes interest on floor plans. Acquirers of business will have to consider these interest expense limitations in terms of the amount of acquisition and other debt financing related to the acquisition.
Lower Tax Rate for C Corporations
Interestingly, the lower C Corporation rate has effectively reduced the benefit to business buyers of purchasing assets versus stock. Still, there are other business reasons to purchase assets over stock; but from a tax perspective, there is a benefit of deducting the cost of an asset that is lesser, simply due to the lower tax rate.
There are many other provisions of the new tax law that impact business owners considering their succession plan, and potential buyers of businesses. Careful review of the new law with advisors is crucial in deciding next steps for your organization. Sikich advisors are working with clients to recommend what changes they should make, if any, to maximize the benefits. Contact a Sikich tax expert today with questions or for a consultation about your plan.