Barbara Andrews, Director – Forensic Services, Association of International Certified Professional Accountants
Tax reform affects more than just taxes. It has lasting implications for all CPAs and introduces some uncertainty for financial forensics and business valuation. Depending on who your clients are, you may feel this more than other CPAs.
If you concentrate in estate and gift tax valuation, now is a good time to start looking outside those business models by leveraging the opportunities that have come up since the new law was signed.
In a recent interview, Don DeGrazia, CPA, ABV, CFF, partner with Gold Gerstein Group LLC, explained the P.L. 115-97, known as the Tax Cuts and Jobs Act, makes the federal estate tax temporarily go away for many tax payers. While state estate or inheritance taxes are still in effect, they don’t provide nearly the same volume of business.
This poses a lot of questions for forensic and valuation professionals – questions that could translate into a very busy, but opportune year.
“It’s big stuff. It’s complicated. And you have to get it right,” said DeGrazia.
Much of the attention from tax reform falls on income tax. But, CPAs also should consider the potentially significant effects this legislation has on other services such as valuing closely-held businesses and family law.
DeGrazia highlighted four key components that require this scrutiny.
1. Cash flow changes
This is the biggie. Provisions in the bill will affect businesses’ cash flow in both directions. For example, §179 and bonus depreciation rules changed to allow businesses to write off 100% of depreciable assets (e.g. a roof) in one year if the asset is bought and placed in service between Sept. 17, 2017, and Dec. 31, 2022 (the percentage then declines through 2025). Businesses will see reduced tax expenditures, which increases cash flow and thus, the value of the business. Great news if the owner is considering selling.
If the company is a pass-through and qualifies for the 20% qualified business income deduction, aka QBID (more on that below), the owners’ tax expenditures dip there, too.
But, it’s not that simple.
If the same company that installed a new roof, let’s say it’s a C corporation named Stan & Sue Inc., also wants to offset income by carrying over last year’s losses, it can’t offset as much as it could under previous law. Net operating loss (NOL) carryforwards are limited to 80% of adjusted taxable income (as defined in the new law) rather than 100%.
So now, Stan and Sue’s tax liability goes back up and their cash flow could change accordingly.
2. Limit on interest deduction
Tax reform caps the deduction for net interest at 30% of adjusted taxable income, with an exemption for smaller businesses. Stan and Sue have leaned toward capitalizing through debt and now change to using more equity, increasing their cost of capital but possibly lowering their “specific company risk” for valuation.
Also, as we have seen in the news, some businesses will use their enhanced cash flow for capital expenditures and employee bonuses.
3. Reasonable compensation
This issue has been a thorn in everyone’s side for years as the IRS and businesses debate what should be considered reasonable. S corporations typically want to keep their compensation lower to minimize payroll tax liability, but QBID has “flipped everything on its head,” DeGrazia noted. Now, S corps may want to boost W-2 compensation to be eligible for this 20% deduction, which is subject to numerous rules. (This Tax Geek article is a great resource to understand more about QBID.)
For fun, take all these factors and move the scenario to 2023, when the 2025 sunset date of the law is getting closer and no one knows if it will be renewed. What does that do to the terminal value in a discounted cash flow analysis? The uncertainty adds a higher element of risk to any model and potentially lowers the firm’s value. So, yes, it’s complicated. Stan and Sue are confused, too.
4. Alimony deduction
Stepping outside the business world, CPAs also need to prepare individual clients for a significant turn in tax law. For divorce agreements signed after Dec. 31, 2018, taxpayers can no longer deduct alimony payments. “This is a sea change,” said DeGrazia. The eliminated deduction effectively increases the cost of alimony and, therefore, is likely to make it more difficult to reach agreements as the paying spouse will want to pay less. Tax reform also allows the spouse receiving the payment to exclude it from taxable income. DeGrazia recommended that CPAs encourage clients to settle their cases and enter into agreements this year if possible.
If these changes leave you with some questions, you’re not alone. The AICPA received more than 4,000 inquiries from attendees in one of its webcasts last month on tax reform. The good news is that you can conquer some of the uncertainty by hearing what DeGrazia and our forensic and valuation experts know on Mar. 6.
Also, the AICPA Tax Reform Resource Center is an excellent resource to help you stay on top of tax reform. It offers comprehensive coverage on all things tax reform. Visit often as the page is updated frequently with guidance, resources, news and videos.
Barbara Andrews, Director – Forensic Services, Association of International Certified Professional Accountants