This month, President-elect Donald Trump will take office and business owners around the country will await clarity on the future of corporate tax law. The incoming administration has positioned itself as pro-business and pro-growth, outlining a tax plan that would potentially grant small businesses more cash flow and financial flexibility.
While there are still many unknowns, business owners can begin to take advantage of available capital and plan for the future of their company – whether they’re looking to restructure their business, exit the market or transition their company to the next generation.
Re-structuring your business
When establishing a business, owners determine which structure best suits the financial and operational needs of their company. But as businesses evolve, they may decide that restructuring is crucial for their continued growth.
Take, for example, a small business owner who initially established his company as a C Corporation. This afforded him the flexibility he needed at the time, but subjected him to tremendous tax liability. His business now qualifies to become an LLC, which he sees as a strategic option to reduce his tax bill while retaining limited liability protection.
However, he has found the taxes imposed on companies restructuring or selling to be prohibitive. During the process of converting his business, taxes on any built-in gains within his company could be realized – a disincentive at the current 35% tax rate. President-elect Trump has proposed lowering the corporate tax rate from 35% to 15%, which would create greater flexibility and opportunity for this owner to restructure.
This potential tax cut may provide an incentive for business owners who have hesitated to act due to tax restrictions. In anticipation, small business owners considering restructuring their companies can begin conversations with their tax accountant or lawyer.
Selling your business
With the prospect of less tax liability and an abundance of affordable capital in the market, it’s fair to expect that both buyers and sellers are getting their books ready – anticipating a hot market and further federal incentives.
Additionally, Trump’s proposed tax policy would allow repatriation of offshore corporate profits at a one-time tax rate of 10 percent. If multinational companies begin bringing their profits stateside and investing in the US, small businesses could benefit from the trickle-down effect of heightened M&A activity.
For owners looking to exit in the coming years, tax cuts would enable them to keep more profits within the business or reinvest them in strategic areas to boost their valuation. But the planning can, and must, begin sooner. Companies preparing for the sale of their business should spend the coming months drafting an airtight, dynamic business plan that can help a buyer envision the growth opportunities.
It’s particularly important for family businesses to get all hands on deck in anticipation of a sale. If Trump’s tax plan goes into effect, owners will need to discuss how additional retained profits would be invested. Oftentimes, older generations prefer to keep more cash on hand, while younger generations want to reinvest it in the company to better position it for sale. Beginning these conversations early can help family businesses identify and resolve issues and develop a plan that works for everyone.
Passing your business to the next generation
In most family businesses, profits and personal income are intrinsically linked. In the coming year, owners will need to consider how changes to their personal tax scenario could impact their business.
Trump has proposed re-structuring the number of tax brackets from seven to three, which would position many high-net-worth business owners for a reduced tax rate on their income. This may enable some to invest further in their business, while it may force others to take a close look at their personal cash flow situation. If an owner is still relying on income from the business, he or she will need to determine how much cash is needed to support their lifestyle and how much should stay in the business. Family businesses preparing to transfer ownership to the next generation should also factor this into their planning.
Changes to the estate tax would also have a substantial impact on heirs inheriting the family business. Both Trump and the Republican Party have indicated that a repeal of the “death tax” is in sight, though there have been various interpretations of Trump’s proposal and how this could be accomplished. In the most basic terms, Trump’s plan would eliminate the estate tax and instead impose a capital gains tax on assets valued over $10 million.
This could significantly lower tax liability for a business owner’s heirs. Currently, the estate tax has a maximum rate of 40 percent, while Trump’s proposed capital gains rate structure would have a top rate of 20 percent for appreciated assets. Even so, some owners may be inclined to evaluate how they’re structuring their assets to reduce their capital gains liability.
A word of caution: later administrations could reinstate this tax. History has shown us that future conditions can easily erode what looked like a good technique or policy change 10 years ago. Instead, financial planning should be focused on building a bulletproof plan that will serve the business well in the long term.
Heading into the new political era, it is safe to expect the incoming administration will encourage business development, growth and activity. While we await formal policy changes, business owners should work with their advisor to establish goals for the coming years and begin needed preparations.
To learn more, contact Wescott Financial.