How the Trump Tax Changes Will Affect Your Exit and Your Business
Early November 2016 saw the end of one of the most contentious political presidential elections in quite some time. Each candidate had distinctly different plans for the direction they wanted to take this country.
From a taxation perspective, Clinton’s platform called for increased taxes for higher income individuals, including income taxes, capital gains taxes, and estate taxes. Trump took a completely opposite approach by promoting a reduction of certain taxes and even the elimination of certain taxes. Having studied the provisions of Mr. Trump’s policy, it’s clear that this administration is looking for high volume of activity to generate the necessary revenue to accomplish his tax policy goals.
A recent study by the Urban-Brooking Tax Policy Center states that Mr. Trump’s tax policies will create a $7 trillion deficit in 10 years and a $22 trillion-dollar deficit by 2036. To debunk those forecasts, this administration is looking to fund the government by exceeding GDP estimates while incentivizing investment in labor, structures, machinery, and equipment.
So how will these tax revisions affect your business and exit? The following are some provisions that have been discussed under the Trump Tax Plan and what they mean to your exit from your business:
Some key points to the Trump Tax Plan include the following:
- Reduction of business income tax from 35% to 15%. This rate is intended to include C-corporations as well as pass through entities such as sole proprietorship, partnerships, and S-corporations;
- Elimination of the Alternative Minimum Tax;
- Reducing income tax brackets from 7 to 3 with the highest bracket now at 33% vs. the current to tax rate of 39.6%;
- Repeal of the estate, gift, and generation skipping transfer taxes; however, they would be replaced with capital gains tax on appreciated assets at the date of death;
- Repeal of the 3.8% Net Investment Income Tax that was introduced by the Affordable Care Act (ACA);
- Immediate expensing of investments made in your business; and
- Elimination of investment interest expense deduction, if expensing election is made.
PERSPECTIVE ON THE PROPOSALS
Clearly, the greatest benefit comes from the reduced individual and corporate income tax rates. Since almost all business acquisitions are executed with after tax dollars (ESOP being the exception), it will become less costly to generate net proceeds to acquire corporate assets or stock. The great news is this will be particularly beneficial to closely held businesses that are transferring internally to family and managers – the most common contractor exit.
In addition, the plan calls for an election to expense all investments in equipment, structures, and inventory, rather than depreciating them. The trade-off is that investment interest expense would not be an allowable deduction.
There is clearly an opening for abuse here where more employees may be categorized as “independent contractors,” thereby getting the benefit of the 15% tax rate versus the higher individual tax rate on wages. This is a concern, but one that has yet to be addressed from an enforcement perspective.
More good news for your exit is the capital gains tax will also see a reduction. The proposed plan calls for continued beneficial tax treatment by allowing taxation at the preferred rates. The plan further calls for the elimination of the Net Investment Income Tax that was created by the ACA and added an additional 3.8% tax on capital transactions based on your income level.
Two other taxes that are subject to repeal are the Alternative Minimum Tax (AMT) and the Estate, Gift, and Generation Skipping Tax. One of the benefits of the elimination of the AMT is that C-corporations that were established years ago may now get better tax benefits from utilizing the section 1202 gain exclusion. If certain C-corporation requirements are met, then the 1202 election provides for a 50% exclusion on the gain of a stock sale.
The catch was that the 50% taxable gain that was taxed at a 28% rate versus the lower 15% or 20% rate and the excluded amount was subject to the AMT. This, in turn, provided very little benefit. The elimination of the AMT will now yield greater results for this strategy. These provisions were modified in 2009 and 2010, allowing for a 75% and 100% exclusion if the corporations were established between 2009 and 2011 and met certain other requirements. This provision is not available to S-corporations or other pass-through entities.
The repeal of the Estate, Gift, and Generation Skipping Tax is another great benefit under this tax plan for business owners. There are too many stories where businesses and families were decimated because of this tax. If this provision does get included in the tax plan, then business owners could spend more time planning for the distribution of assets to successors and not how to liquidate those assets to pay the tax.
However, there is a trade-off to this provision. Under Mr. Trump’s plan, a capital gain tax will be imposed on the appreciated value of the deceased's assets. In other words, the assets will be treated as being sold at date of death, and the “gain” would be taxed at capital gains rates to the estate. There would be an exclusion to the gain of $5 million for single filing individuals and $10 million for married couples.
Based on what we’ve learned to date, exiting your business will still be taxing; however, it does seem that greater opportunities to save tax dollars on your exit will be available. After all, it’s not so much what you get that’s important, it’s what you get to keep.
Major tax reform is one of the topics at the top of this administration’s list and one that will likely see action within the first 100 days. If you are a business owner, then careful consideration should be given to the various tax-saving strategies that will be coming down the road in the near future.
If you are planning on exiting your business, comprehensive planning should be at the top of your list, which includes risk management, succession, value building, and taxes. A successful exit is one where each of these strategies works in concert with your business, personal, and financial planning spheres.
U.S. Treasury Circular 230 requires that this firm advise you that any tax advice provided was not intended or written to be used, and cannot be used by you, for the purpose of avoiding penalties that the IRS could impose upon you.
Joe Bazzano is the COO of Beacon Exit Planning, America’s Exit Planner®, a certified public accountant, certified valuation analyst and a certified business exit consultant with over 20 years of experience in public accounting, valuation and exit strategy services to closely held companies ranging from $100,000 to $250 million. Learn more at www.BeaconExitPlanning.com.