How to slim Uncle Sam’s tax share
We all know by now that saving as much as possible on taxes is “yuuugely” smart. But now that President Trump’s tax plan is slowly coming together, it’s time to ponder how to take advantage of what will likely be a better situation for franchisees.
The first inklings of the Trump tax plan came out this spring, promising to slash the corporate tax rate from typical pass-through businesses (like LLCs) from a maximum of 35 percent to 15 percent, abolish completely the estate tax and possibly change how U.S. and overseas taxes are tallied.
For those caught up in the flurry of M&A, the new tax ideas won’t do much, trimming just the 3.8 percent tax designed to fund the Affordable Care Act. That would bring the capital gains rate down to 20 percent instead of 23.8 percent.
The new plan would be a radical change, but whether it will actually become law after the tax outline goes through Congress is anyone’s guess. That legislation is just starting in Washington, D.C.
For tax gurus Dennis Monroe and Rick Gibson of law firm Monroe Moxness Berg, it’s an exciting time. “This could be a once-in-a-generation opportunity to change the tax code versus the baby steps and short-term provisions of the past few decades,” said Gibson during a tax talk at Franchise Times’ Finance & Growth Conference this spring. So what’s a business owner to do? Wait, defer and deduct.
“We don’t know when this is going to take place, is it going to be retroactive, middle of next year? The idea that we have is accelerating deductions and eliminating income as best you can. It’s not going to get any worse,” said Monroe. “If you can wait, I certainly would on capital gains.”
For those looking to take advantage of the loose capital and high multiples before the business cycle moves on, however, waiting might not be an option to shed the 3.8 percent of capital gains.
John Sensiba, managing partner at Sensiba San Filipo, said there are many ways to save on taxes for the buyer and seller, but finding the right balance for each party can be quite a negotiation. “A buyer and seller have conflicting positions; they’re adversarial even in a friendly deal,” said Sensiba. “Both want a good tax result. So if I’m buying, I want to buy assets and depreciate them. If I’m selling, I want to sell stock because I want to get capital gain treatment.”
Carl Berry, a tax attorney with Trenam Law, lives and breathes corporate taxes. He said to attract strategic buyers who have a lot of options these days, it’s all about assets.
“The best thing you can do for a buyer in terms of making your company more attractive is to deliver to them a step-up in basis of the assets they’re buying, including goodwill. The simplest way is to sell them assets as opposed to stock or equity in your company,” said Berry. “That’s kind of the gold standard for what the buyer wants.”
Doing things like remodels, updating equipment updates or real-estate improvements can help drive up the value of tangible capital assets. As for goodwill—the intangible parts of a transaction like a good management team, strong community ties and great brand resonance—there’s not a lot one can do in short order. But operators looking to grow their company value should look seriously at enhancing those goodwill elements.
Sellers looking to acquire can do a few things to make their bid attractive as well. One of the biggest is purchasing over time. While it adds complexity to the transaction, a longer term could spread out the tax liability, slashing the capital gains rate for sellers by moving them from short-term capital gains to long-term capital gains.
That could mean a 10 percent dip in taxes for the seller, especially sellers who are retiring and will drop to one of the lower tax brackets.
Despite all the M&A activity right now, Sensiba said unless the crystal ball portends some dark times ahead, keep enhancing the business until the Trump tax efforts are finalized and those savings could increase even more. “For people who are contemplating a big transaction, we’re telling them unless there is a market risk to waiting, then wait,” said Sensiba.