Impact of New Tax Law on Agency Profitability
With the passing of the Tax Cuts & Jobs Act of 2017 (TCJA), there is quite a lot of talk about how it will impact businesses, what businesses are doing with any additional monies, as well as what happens to employees.
What Large Corporations May Do
Because of the new tax reform, many companies, such as Marsh & McLennan, FedEx, Travelers, Walmart, BB&T, etc., are giving one-time bonuses of $1,000 or more, increasing hourly rates and/or paying additional contributions to pension and profit sharing or 401(k) plans.
There are predictions that companies, such as Apple, will invest more capital expenditures to grow and hire more people. It is also predicted that some companies that have been taking some, or all, of their operations overseas will likely consider investing more in America and especially in those states with more friendly tax environments.
The stock market responded positively in the days after the new tax reform was announced as corporations will likely have more profit and a better outlook for the future. In general, economic growth seems favorable for the near future.
C Corporations
What does the new tax law mean to agency owners? That depends on the type of entity that the business operates under. For agencies that are a C corporation, all taxable income at the corporate level is now a flat 21 percent. This is compared to the previous range of 15 percent to 39 percent, based on various bracketed income levels.
Many owners of C corporations will bonus out money before the end of the year, so there is often not much taxed at the corporate level. In those cases, the new rate might not change things that much. However, for those selling the assets of the agency and have a C corporation, they are faced with a double tax. In that situation, the 21 percent flat rate most likely would be much lower than the previous rate they would have paid.
Pass-Through Entities
For sole proprietorships, LLCs, partnerships and S corporations that are pass-through entities (not all are), the new tax law creates a 20 percent deduction of income before taxes. If the agency has $500,000 in gross revenue and $400,000 in expenses, the net income is $100,000. The new tax law allows a 20 percent deduction from that income, so the owner/taxpayer can record $80,000 as business income instead of $100,000. The term one will need to learn and understand is Qualified Business Income (QBI), which defines how that net income is actually calculated.
There are limitations to that deduction for personal service businesses, where the limitation is $157,500 for single taxpayers and $315,000 for couples filing jointly. For employee-driven businesses, the 20 percent deduction is limited to 50 percent of payroll. Agency owners need to get sound tax advice on what their compensation should be in order to maximize the tax benefit.
Personal Income Taxes
The key features of the new tax plan on personal income taxes are:
- A lower maximum tax rate;
- A major increase in the standard deduction; and
- Limits to deductions for state taxes and mortgage interest.
These changes will cost those in high state tax areas with expensive homes and benefit those who do not normally have a lot of deductions.
In general, the middle class will see a reduction in their taxes, especially because the standard deduction is now $12,000 for an individual taxpayer (up from $6,500) and $24,000 for a couple filing jointly (up from $13,000). Employees are now noticing their paychecks have additional spending money because of their lower personal tax from these changes.
Tax on Mergers & Acquisitions
The new tax law has a lot of changes that can significantly impact the major players in the agency mergers and acquisitions (M&A) arena, such as the deductibility of interest, calculations and use of net operating losses (NOL). The dust needs to settle before a clear trend can be seen. However, it will either keep things more or less the same, or possibly increase the drive for more acquisitions.
What does the new tax law mean to agency owners? That depends on the type of entity that the business operates under.
For those selling their agencies, the federal capital gains tax rates have not changed and remain between 0 percent and 20 percent based on the seller’s income, assuming the asset was held over one year. This is just another good reason for selling at this time, including the extraordinary multiples of EBITDA (earnings before interest, tax, depreciation and amortization) being paid by those national firms that have capital from private equity firms wanting to invest in the insurance industry.
Oak & Associates and other consulting firms involved in mergers and acquisitions do not see this trend discontinuing for the next few years.
Estate Taxes
The lifetime exemption from estate and gift taxes will double for 2018 from $5.6 million for an individual and $11.2 million for a couple to $11.2 million for an individual and $22.4 million for a couple. After those limits, the estate tax rate remains at 40 percent. This will potentially benefit many of those who haven’t already adequately protected their estate and who can now take advantage of the higher limits on the lifetime exemptions.
Summary
First, the tax law is certainly not a significant simplification of the law. It helps in some areas and complicates things in other areas. It is recommended that businesses get qualified advice because of the unique changes to business taxes under the new law. Overall, it is certainly favorable to businesses both small and large. The middle-class taxpayer will also see savings. Most experts agree that the new tax plan will benefit the U.S. economy for years to come.