Last November marked the end of one of the most contentious 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, Hillary Clinton’s platform called for increased taxes for higher income individuals including income, capital gains and estate taxes. Donald Trump took a completely opposite approach by promoting a reduction of certain taxes and the elimination of others. Having studied provisions of his tax policy, it’s clear that this new administration is looking for a high volume of business activity to generate the necessary revenue to accomplish his goals.
A recent study by the Urban-Brooking Tax Policy Center states that Trump’s tax policies will create a $7 trillion deficit in 10 years and a $22 trillion deficit by 2036. In order to debunk those forecasts, this administration is looking to fund the government by exceeding gross domestic product estimates while incentivizing investment in labor, structures, machinery and equipment.
That generally sounds good for roofing contractors. So how will these tax revisions affect your business and exit? Let’s explore some of the key points to the Trump tax plan.
- Reduction of business income tax from 35 to 15 percent. 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 seven to three with the highest bracket now at 33 percent compared to today’s tax rate of 39.6 percent.
- Repeal of the estate, gift and generation-skipping transfer taxes. However, they’d be replaced with capital gains tax on appreciated assets at the date of death.
- Repeal of the 3.8 percent Net Investment Income Tax introduced by the Affordable Care Act.
- Immediate expensing of investments made in your business.
- Elimination of the investment-interest expense deduction, if expensing election is made.
Clearly, the greatest benefit of Trump’s plan comes from the reduced individual and corporate income tax rates. Since almost all business acquisitions are executed with after-tax dollars — with an employee stock ownership plan 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, which is the most common exit among roofing contractors.
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 the investment interest expense would not be an allowable deduction.
There’s clearly an opening for abuse here where more employees may be categorized as “independent contractors,” thereby getting the benefit of the 15 percent tax rate vs. 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 created by the Affordable Care Act, which added 3.8 percent in taxes 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 established years ago may now get better tax benefits from utilizing the section 1202 gain exclusion. If certain C corporation requirements are met, the 1202 election provides for a 50 percent exclusion on the gain of a stock sale.
The catch was that the 50 percent taxable gain was taxed at a 28 percent rate versus the lower 15 or 20 percent rate, and the excluded amount was subject to the AMT. This, in turn, provided very little overall benefit. The elimination of the AMT will now yield greater results for this strategy. These provisions were modified in 2009-2010, allowing for a 75 and 100 percent exclusion if the corporations were established between 2009-2011, and met certain other requirements. This provision is not available to S corporations and other pass-through entities.
The repeal of the Estate, Gift and Generation Skipping tax is another great benefit for business owners. There are too many stories where businesses and families were decimated by this tax. If this provision is included in the tax plan, 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.
There is a trade-off to this provision, however. Under Trump’s plan, a capital gains tax will be imposed on the appreciated value of a deceased persons assets. In other words, the assets will be treated as being sold at the 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 appear 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 compared to what you get to keep.
Major tax reform is one of the topics at the top of this administration’s list and one likley to see action within Trump’s first 100 days. If you’re a business owner, careful consideration should be given to the various tax-saving strategies coming in the near future.
If you’re planning on exiting your business, comprehensive planning should be at the top of your list, which includes risk management, succession, value building and, of course — taxes. A successful exit is one where each of these strategies works in concert with your business, personal and financial planning spheres to support your exiting goals.
Editor’s Note: U.S. Treasury Circular 230 requires that any tax advice provided in this column is not intended or written to be used, and cannot be used by you, for the purpose of avoiding penalties that the IRS could impose.