Smith Schafer Principal, John Edson, presented a free educational seminar Business Valuations for SBA and Banking Purposes at the Rochester Golf & Country Club. Click below to view full presentation.
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If you would like to learn more about business valuations for SBA and banking purposes business, Smith Schafer can help. For additional information click here to contact us. We look forward to speaking with you soon.
One of the biggest changes under the Tax Cuts and Jobs Act (TCJA) is the permanent installation of a flat 21% federal income tax rate for C corporations for tax years beginning after 2017. The new 21% rate applies equally to personal service corporations (PSCs). (Under prior law, PSCs were taxed more heavily than other C corporations.)
This is great news if you own or manage a C corporation, including a PSC. Here are specific tax planning considerations for these entities under the TCJA:
DEFER BUSINESS INCOME
With the reduced federal income tax rate for C corporations, tax planning is now much easier, because you know this year’s rate and next year’s rate: 21%. Therefore, the generally appropriate strategy is to defer income into next year and accelerate deductible expenditures into this year. That way, you postpone corporate federal income tax bills.
Most small and medium businesses are now allowed to use cash-method accounting for tax purposes, thanks to other changes included in the TCJA. Assuming your business is eligible, cash-method accounting gives you flexibility to manage your corporation’s 2018 and 2019 taxable income to defer some corporate federal income tax until next year.
Examples of ways to defer income include:
Delaying invoices. On the income side, the general rule for cash-basis taxpayers is you do not have to report income until the year you receive payment. To take advantage of this rule, put off sending out some invoices so your corporation does not get paid until early next year. Of course, you should never do this if it raises the risk of not collecting your money.
Charging recurring expenses before year end. You can charge recurring business expenses that your corporation would otherwise pay early next year on credit cards. Cash-basis taxpayers can claim 2018 deductions even though the credit card bills won’t be paid until next year. However, this favorable treatment does not apply to store revolving charge accounts. For example, you cannot deduct business expenses charged to your Sears account until you pay the bill.
Paying expenses with checks and mail them a few days before year end. The tax rules say cash-basis taxpayers can deduct the expenses in the year checks are mailed, even though they won’t be cashed or deposited until early next year. For big-ticket expenses, send checks via registered or certified mail. That helps prove they were mailed this year.
Prepaying expenses for next year. Cash-basis taxpayers can deduct prepaid expenses in the current tax year as long as the economic benefit from the prepayment does not extend beyond the earlier of:
- ) 12 months after the first date on which your company realizes the benefit, or
- ) the end of your company’s 2019 tax year (the tax year following the year in which the payment is made).
For example, this rule allows your company to claim 2018 deductions for prepaying the first three months of next year’s office rent or the premium for property insurance coverage for the first half of next year.
MAKE THE MOST OF BONUS DEPRECIATION
For qualified property acquired and placed in service between September 28, 2017, and December 31, 2022 (or December 31, 2023 for certain property with longer production periods and aircraft), the TCJA increases the first-year bonus depreciation percentage to 100% (from 50% for most of 2017). This break is allowed for both new and used qualified property. As long as 100% first-year bonus depreciation is allowed, it is superior to the Section 179 deduction privilege (explained below), because there are fewer restrictions on bonus depreciation.
TAKE ADVANTAGE OF THE LIBERALIZED SECTION 179 RULES
For qualifying property placed in service in tax years beginning after December 31, 2017, the TCJA permanently increases the maximum Section 179 deduction to $1 million (from $510,000 for tax years beginning in 2017). The Sec. 179 deduction phase-out threshold also has been increased to $2.5 million (from $2.03 million under prior law). Both amounts can be adjusted for inflation in future years.
In addition, the TCJA expands the definition of eligible property to include certain depreciable tangible personal property used predominantly to furnish lodging. Examples of such property include beds, other furniture, kitchen appliances, and other equipment used in the living quarters of a lodging facility such as an apartment house, dormitory or any other facility (or part of a facility) where sleeping accommodations are provided and rented out.
The definition of qualified real property eligible for the Sec. 179 deduction is further expanded to include qualified expenditures for roofs, HVAC equipment, fire protection and alarm systems, and security systems for nonresidential real property.
As under prior law, Sec. 179 deductions can still be claimed for qualifying real property expenditures, up to the maximum annual allowance ($1 million for tax years beginning in 2018). There’s no separate limit for real property expenditures, so Sec. 179 deductions claimed for real property reduce the maximum annual allowance dollar for dollar.
BUY A “HEAVY” VEHICLE
Purchasing large SUVS, pickups and vans can provide major tax advantages. Thanks to the unlimited 100% first-year bonus depreciation break for qualified assets that are acquired and placed in service between September 28, 2017, and December 31, 2022, you can generally write off 100% of the cost of a new or used heavy SUV, pickup or van that’s acquired and placed in service in current tax year on this year’s corporate tax return.
To cash in on this favorable tax treatment, you must buy a “heavy” vehicle with a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds. First-year depreciation deductions for lighter SUVs, trucks, vans and passenger cars are much skimpier. You can usually find a vehicle’s GVWR specification on a label on the inside edge of the driver’s side door where the hinges meet the frame.
For example, suppose your C corporation buys a $65,000 heavy SUV in 2018. You can write off the entire $65,000 cost in the current tax year thanks to the 100% first-year bonus depreciation break. This break is available for both new and used heavy vehicles.
In contrast, suppose your corporation spends the same $65,000 on a car or a light pickup or van. In this scenario, the first-year depreciation write-off will be only $18,000, including $8,000 of first-year bonus depreciation.
As its name implies, the new tax law includes many provisions that help C corporations cut their tax bills. In many ways, it also simplifies tax planning for C corporations. A Smith Schafer professional can supply more details on what is covered here and suggest other creative tax-planning moves for your business.
Most business owners are reactive when it comes to having their businesses valued. But there are many times it pays to be proactive. Some valuations are necessities, such as for determining the value of the business interest in an estate. Others are obtained for more elective reasons, but are helpful to business owners nevertheless and help business owners with planning strategies.
It is a good idea to review these common valuation scenarios, so you can identify when it is time to obtain your own valuation. Below are 10 reasons to have your business or a business interest valued.
1. SUCCESSION PLANNING
- Business succession transactions may be accomplished by gifting the ownership to family. Gifting is most common with family successions.
- The business may be sold to employees, third parties, or may be combined with some amount of gifting. This type of transfer of ownership will be based on the value determined when the business is valued on an as-is, on-going basis.
- Businesses may be sold to a strategic buyer (someone in the industry). A transaction with a strategic buyer usually occurs at a value higher than the amount determined with for a traditional transfer to family, employees or an individual buyer with no other connections to the industry. The buyer may incorporate the revenue streams into their existing business and will be able to achieve increased profit and cash flow by consolidating specific overhead expenses.
Example: Two facilities may not be needed and common business functions, such as administrative may be consolidated and the costs may be eliminated. A specific Valuation engagement may be performed to determine an estimated value of the business if it is sold to a strategic buyer.
2. ESTATE AND GIFT TAX
- You might need a business valuation not only to file an estate tax return, but also to provide guidance to the personal representative to fulfill the terms of the decedent’s will.
- As long as the federal (and some state) estate tax remains in place, it is likely that effecting a gift to minimize ultimate estate tax will require the valuation of a business or a business interest.
3. SALES, MERGERS AND ACQUISITIONS
- A valuation is typically performed when a company acquires another company, is targeted for an acquisition, reorganizes its capital structure, splits up or files for bankruptcy while in liquidation or reorganization.
- A merger generally requires both parties to get a valuation, while in an acquisition, it may only be one party.
- These valuations may create challenges, which require the valuation analyst to calculate cash equivalents for payment (i.e. stock versus cash).
4. BUY/SELL AGREEMENTS
- A valuation may be necessary in order for a business to develop a buy/sell agreement. These agreements can serve tax or business purposes. If a sale will involve related parties, a valuation might be necessary to insure a proper value for estate and gift tax purposes.
- A buy/sell agreement allows an owner in a closely-held business to acquire the interest of another owner in the event another owner decides to retire, exit, or passes away.
- These agreements many times include a designated price or formula to determine the price the remaining owners would pay to acquire the interest of the exiting owner.
- This price or formula should be occasionally reviewed by a valuation analyst in order to keep up to date with the performance of the company over time.
5. SHAREHOLDER & PARTNERSHIP BUYOUTS/DISPUTES
- Ownership disputes result from many different circumstances, most commonly including: disagreements between owners, disagreement with a merger or dissolution, or other related issues.
- Many states allow businesses to merge, dissolve, or restructure without a unanimous ownership consent. This may result in a dispute that requires a valuation as part of the settlement process.
6. ALLOCATION OF PURCHASE PRICE (TAX & FINANCIAL REPORTING)
- In the event of a business transaction (i.e. merger, acquisition, sale, etc.), the purchaser and the seller need to properly record the sale.
- Inconsistent and inappropriate allocation of the purchase price may result in an increased tax liability, and even penalties.
- A valuation analyst will consider the differences in business goodwill over personal goodwill and the various state laws applying to these transactions and calculations.
7. MARITAL DISSOLUTION (DIVORCE)
- When a private business owner gets divorced, a valuation may be required to divide the marital estate, whether by agreement of the parties or by a judge through a trial. Often both sides obtain separate valuations, but there is also a movement toward collaborative divorces in which the parties agree to hire a single valuation analyst.
8. INSURANCE PURPOSES
- Closely-held business owners will sometimes pursue a valuation in order to determine a value necessary to cover their business interest value if something were to happen to them. This value is then purchased as “key person insurance.”
- In the event something happens, the insurance could payout value to the owner’s family to allow them to continue the owner’s role, or buy themselves out of the owner’s role. These rules are subject to buy/sell agreements and terms within the key person insurance policy.
9. FINANCING/SBA LOAN
- Financial institutions and the SBA may require a business valuation in order to underwrite and approve a loan especially when the loan is to acquire a business or a business interest.
- Typically, financial statements are presented at historical cost. A valuation will provide the bank with fair market value amounts that can support a loan.
- An employee stock-ownership plan (ESOP) is an employee benefit plan that invests in employer common stock. ESOPs provide capital, liquidity, and certain tax advantages to those private businesses whose owners do not wish to go public.
- A valuation must be performed annually for an ESOP. This valuation determines the price per share for the beneficiaries of the ESOP plan. It is a very important valuation, because the ESOP trustees may be held personally liable if a beneficiary receives less than the fair market value of the stock.
- This is required in order to comply with IRS and Department of Labor rules.
This is but a partial list of potential reasons to have your business valued. In each of these instances, it is important to have your business valued by a credential valuation professional. Smith Schafer works with business owners, in multiple industries, to uncover the true value of their companies’ tangible and intangible assets.
We look forward to speaking with you!
Smith Schafer Valuation Expert, John Edson, presented at our free educational seminar at Rochester Golf & Country Club April 25, 2018. John discussed building value in your business. Click below to view full presentation.
If you would like to learn more about building value in your business, Smith Schafer can help. For additional information click here to contact us. We look forward to speaking with you soon.
Business valuation is an evolving discipline. In some jurisdictions, investment value — rather than fair market value — has emerged as the preferred standard of value in some divorce cases. This trend is important to monitor to ensure your valuation expert estimates the correct standard of value. If not, a court may disregard his or her conclusion.
Investment Value Definition
Fair market value, which is the most common standard of value, estimates the value that the universe of hypothetical buyers and sellers would agree on for an interest in the subject company. It is customarily defined by IRS Revenue Ruling 59-60, but it also may be appropriate for valuations prepared for purposes other than federal taxes.
On the other hand, investment value captures “the value to a particular investor based on individual investment requirements and expectations,” according to the International Glossary of Business Valuation Terms. (This publication is a joint effort of the most prominent business valuation organizations.)
Investment value reflects a particular investor’s subjective goals regarding expected returns, acceptable risk, desired tax attributes, and potential synergies with other businesses. This type of investor could be a potential equity or debt holder — or an existing or prospective operator-owner — traditionally in a merger and acquisition.
Some jurisdictions have begun to use investment value — also known as the “value to the holder” — to determine business value to distribute assets equitably between the parties in a divorce.
INVESTMENT VALUE IN DIVORCE
According to the business valuation textbook, Standards of Value: Theory and Applications:
“Value to the holder considers the business or business interest in the hands of its owner, regardless of whether he or she intends to sell the business. It further assumes that the entitled spouse will continue to enjoy the benefits generated by a business that was created or appreciated during the marriage.”
In a divorce context, the use of investment value — rather than fair market value — it an important distinction to make, because affects a valuator’s assumptions and methodology. For example, when estimating investment value for a divorce, an appraiser might consider the actual tax burden of a pass-through entity, rather than the taxes the company would incur if it operated as a C corporation.
When an appraiser applies the investment value standard, valuation discounts for lack of control and marketability are usually less relevant, especially if one spouse controls the business. That’s because the goal is to measure the full value of the interest to the husband and wife, not the universe of all buyers and sellers who might discount private business interests. As a Virginia court opined in Patel v. Patel (2013 VA App. LEXIS 110):
“Courts valuing marital property for the purpose of making a monetary award must determine…that value which represents the property’s intrinsic worth to the parties.”
Investment value may contradict with how some jurisdictions treat personal goodwill, however. Courts in some states have interpreted the law to mean that investment value eliminates some (or all) personal goodwill from the value of the interest. Others contend that you cannot summarily exclude personal goodwill if the intention is to measure the full value of the interest to the husband and wife. This remains a controversial topic among business valuation professionals.
EVOLUTION OF INVESTMENT VALUE
There is more than one way to define the term “value.” Investment value is an alternative to fair market value. It started as way to help debt and equity investors estimate value in business combinations and strategic decision-making. Now divorce courts are also embracing investment value when splitting up marital assets. But the overriding goal remains the same: To measure the full value to a particular investor, which are the owner-operating or investor in a sale — or the husband and wife in a marital dissolution case.
Most businesses will receive a big tax cutstarting with their 2018 tax years, thanks to the new law enacted on December 22, 2017. But some industries (such as retail, hospitality and banking) generally expect to reap more benefits than others (such as certain professional practices). The provisions in the law — known as the Tax Cuts and Jobs Act (TCJA) — are generally effective for tax years beginning after December 31, 2017 (except where noted otherwise). And, unlike the provisions for individual taxpayers, many of these provisions are permanent.
HERE’S AN OVERVIEW OF SOME OF THE CHANGES THAT AFFECT BUSINESSES:
Corporate Tax Cut
Under prior law, C corporations paid graduated federal income tax rates of 15%, 25%, 34% and 35% on taxable income over $10 million. Personal service corporations (PSCs) paid a flat 35% rate. For tax years beginning after December 31, 2017, the TCJA establishes a flat 21% corporate rate. That reduced rate also applies to PSCs.
Elimination of Corporate Alternative Minimum Tax (AMT)
Under prior law, the corporate AMT was imposed at a 20% rate. However, corporations with average annual gross receipts of less than $7.5 million for the preceding three tax years were exempt. For tax years beginning after December 31, 2017, the TCJA repeals the corporate AMT.
Capital Asset Expensing and Depreciation Provisions
In general, businesses will be able to deduct more for capital expenditures in the first year they are placed in service, and in some cases depreciate any remaining amounts over shorter time periods. Two key tax breaks allow for accelerated expensing:
- Expanded Section 179 deductions. Under the TCJA, for qualifying property placed in service in tax years beginning after December 31, 2017, the maximum Sec. 179 deduction increases to $1 million (up from $510,000 for tax years beginning in 2017) and the Sec. 179 deduction phaseout threshold increases to $2.5 million (up from $2.03 million for tax years beginning in 2017). The TCJA also expands the definition of eligible property to include certain depreciable tangible personal property used predominantly to furnish lodging. The definition of qualified real property eligible for the Sec. 179 deduction is also expanded to include qualified expenditures for roofs, HVAC equipment, fire protection and alarm systems, and security systems for nonresidential real property.
- More generous first-year bonus depreciation. Under the TCJA, for qualified property placed in service between September 28, 2017, and December 31, 2022 (or by December 31, 2023, for certain property with longer production periods), the first-year bonus depreciation percentage is increased to 100% (up from 50% in 2017). The 100% deduction is allowed for both new and used qualifying property.
Note: In later years, the first-year bonus depreciation deduction is scheduled to be reduced as follows:
- 80% for property placed in service in calendar year 2023,
- 60% for property placed in service in calendar year 2024,
- 40% for property placed in service in calendar year 2025, and
- 20% for property placed in service in calendar year 2026.
For certain property with longer production periods, the preceding cutbacks are delayed by one year. For example, the 80% deduction rate will apply to property with long production periods that are placed in service in 2024.
Deductions for Passenger Vehicles Used for Business
For new or used passenger vehicles placed in service after December 31, 2017, and used over 50% for business, the maximum annual depreciation deductions allowed under the TCJA are:
- $10,000 for the first year,
- $16,000 for the second year,
- $9,600 for the third year, and
- $5,760 for the fourth and subsequent years until the vehicle is fully depreciated.
For 2017, the limits under the prior law for passenger cars are:
- $11,160 for the first year for a new car or $3,160 for a used car,
- $5,100 for the second year,
- $3,050 for the third year, and
- $1,875 for the fourth and subsequent years.
Slightly higher limits apply to light trucks and light vans.
Limits on Business Interest Deductions
Prior law generally allowed full deductions for interest paid or accrued by a business (subject to some restrictions and exceptions). Under the TCJA, affected corporate and noncorporate businesses generally can not deduct interest expense in excess of 30% of “adjusted taxable income,” starting with tax years beginning after December 31, 2017.
For S corporations, partnerships, and LLCs that are treated as partnerships for tax purposes, this limit applies at the entity level, rather than at the owner level.
For tax years beginning in 2018 through 2021, you must calculate adjusted taxable income by adding back allowable deductions for depreciation, amortization and depletion. After 2021, these amounts aren’t added back when calculating adjusted taxable income. Business interest expense that is disallowed under this limitation is treated as business interest arising in the following taxable year. Amounts that can not be deducted in the current year can generally be carried forward indefinitely.
Note: Some taxpayers are exempt from the interest deduction limitation, including:
- Taxpayers (other than tax shelters) with average annual gross receipts of $25 million or less for the three previous tax years,
- Real property businesses that elect to use a slower depreciation method for their real property, and
- Farming businesses that elect to use a slower depreciation method for farming property with a normal depreciation period of 10 years or longer.
Another exemption applies to interest expense from dealer floor plan financing. For example, this exemption applies to dealers that finance purchases or leases of motor vehicles, boats or farm machinery.
Deductions for Business Entertainment and Certain Employee Fringe Benefits
Under prior law, taxpayers could generally deduct 50% of expenses for business-related meals and entertainment. Meals provided to an employee for the convenience of the employer on the employer’s business premises were 100% deductible by the employer and tax-free to the recipient employee. Various other employer-provided fringe benefits were also deductible by the employer and tax-free to the recipient employee.
Under the TCJA, deductions for business-related entertainment expenses are completely disallowed for amounts paid or incurred after December 31, 2017. Though meals purchased while traveling on business are still 50% deductible, the 50% disallowance rule also now applies to meals provided via an on-premises cafeteria or otherwise on the employer’s premises for the convenience of the employer. After 2025, the cost of meals provided through an on-premises cafeteria or otherwise on the employer’s premises won’t be deductible.
In addition, the TCJA disallows employer deductions for the cost of providing commuting transportation to an employee (such as hiring a car service), unless the transportation is necessary for the employee’s safety. And the new law eliminates deductions by employers for the cost of providing qualified employee transportation fringe benefits (for example, parking allowances, mass transit passes, and van pooling). However, those benefits are still tax-free to recipient employees.
Foreign Tax Provisions
The TCJA includes many changes affecting business taxpayers with foreign operations. In conjunction with the new 21% corporate tax rate, these changes are intended to encourage multinational companies to conduct more operations in the U.S., with the resulting increased investments and job creation in this country.
Other noteworthy provisions of the TCJA that may affect your business include:
- Cash method accounting. The new law liberalizes the eligibility requirements for electing the more-flexible cash method of accounting, making that method available to many more medium-size businesses. Also, eligible businesses are excused from the chore of doing inventory accounting for tax purposes.
- Net operating losses (NOLs). For NOLs that arise in tax years ending after December 31, 2017, the maximum amount of taxable income for a year that can be offset with NOL deductions is generally reduced from 100% to 80%. In addition, NOLs incurred in those years can no longer be carried back to an earlier tax year (except for certain farming losses). Affected NOLs can be carried forward indefinitely.
- Excess business losses. A new limitation applies to deductions for “excess business losses” incurred by noncorporate taxpayers. Losses that are disallowed under this rule are carried forward to later tax years, and then they can be deducted under the rules that apply to NOLs. This new limitation applies after applying the passive activity loss rules. However, it only applies to an individual taxpayer if the excess business loss exceeds the applicable threshold.
- Like-kind exchanges. The Section 1031 rules that allow tax-deferred exchanges of appreciated like-kind property are allowed for only real estate for exchanges completed after December 31, 2017. Under the TCJA, like-kind exchanges of personal property assets aren’t permitted. However, prior law applies if one leg of an exchange was completed as of December 31, 2017, but another leg of the exchange remained open on that date.
- Officers’ compensation. Deductions for compensation paid to principal executive officers generally can not exceed $1 million a year. A transition rule applies to amounts paid under binding contracts that were in effect as of November 2, 2017.
- R&D expenses. Under prior law, eligible research and development expenses can be deducted in the current period. Starting with tax years beginning after December 31, 2021, specified R&D expenses must be capitalized and amortized over five years, or 15 years if the R&D is conducted outside the U.S.
- Rehab credits. For amounts paid or incurred after December 31, 2017, the TCJA repeals the 10% rehabilitation credit for expenditures on pre-1936 buildings. The new law continues the 20% credit for qualified expenditures on certified historic structures, but the credit must be spread over five years. Certain transition rules apply.
- Domestic production activities deduction (DPAD). The DPAD, which could be up to 9% of eligible income, is eliminated for tax years beginning after December 31, 2017.
- Lobbying expenses. The deduction for local lobbying expenses is eliminated.
The TCJA is almost 500 pages long and covers a wide range of topics. We have summarized ONLY the highlights here.