June 01, 2018 Substantive Law

The TCJA and Business Valuations

By Karen Platt

Reprinted with permission from Section of Family Law Newsletter, May 2018. ©2018 by the American Bar Association. Reprinted with permission. All rights reserved. This information or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

For most family law practitioners, our attention around the 2017 Tax Cuts and Jobs Act (TCJA) has been focused on issues regarding the non-deductibility of spousal support for orders issued and agreements entered into after December 31, 2018. However, the TCJA has a much broader reach than just the new alimony rules. For example, there are changes to estate, gift and generation skipping tax rules that may be important in the negotiation and drafting of prenuptial agreements. For us on the Marital Property Committee, our attention has been focused on the fact that the TCJA will almost certainly have an impact on business valuations as well and, therefore, a potential impact on our practice. We hope that this article will help flag issues of which the family law practitioner should be mindful when encountering business valuation issues under the TCJA.

For the most part, the TCJA is anticipated to lead to increased business valuations, rather than decreased. Most significantly, the new law collapses the Federal Corporate Tax Rates from a scale with a maximum of 35 percent to a flat 21 percent. In addition, the new law provides for accelerated depreciation and the ability to expense certain capital expenditures made through 2022. These two changes are expected to lead to the increased valuation. Some other factors that might have a negative impact on business valuations include increased capital costs, limits on interest expense deductions, Net Operating Loss (NOL) deduction limitations, and a repatriation tax on foreign assets. Over all, though, it is anticipated that the net impact on business valuations due primarily to the decreased tax rates, will be positive.

These changes are likely to have the greatest impact on an income approach to valuation but will also impact a market approach. The income approach changes are most obviously due to the lower tax rates will leave corporations with greater net earnings. The impact will vary from company to company, with a greater impact on companies with greater revenues—the ones that paid higher tax rates before TCJA. In the market approach, a review of comparable business valuations and sales will need to take into consideration the timing of those prior valuations sales—were they before or after the new tax law was enacted, or anticipated? Accountants will have to make appropriate adjustments to multiples used in valuation. Notably, for entities that hold significant capital assets, adjustments will need to be made in valuation because of the changes in the depreciation rules.

Although the changes discussed above refer to the taxation of C Corporations, the TCJA brings about changes for some pass-through entities (i.e., S Corporations, Limited Liability Companies and Partnerships). For these pass-through entities (PTEs), income is taxed at the shareholder/owner level and not at the corporate level. To address the inequality that arises because of the reduced tax rate for C Corporations under the TCJA, the new law also provides that owners of certain PTEs can deduct 20 percent of their “qualified business income” (QBI) in determining their taxable income on their personal returns. It is important to note that this QBI deduction (a) is permitted in only some industries (alas, the deduction is not applicable to law firms), and (b) is in effect only until 2025.

But what does this all mean? Not surprisingly, it is impossible to predict just what impact these changes will have on business valuations, particularly given that some of these changes made in the TCJA are temporary. What’s a practitioner to do if confronted with a business valuation in this post-TCJA world? Read everything you can find about the TCJA and its potential impact on business valuations and keep open lines of communication with your forensic accountants about their methodologies and how they are accounting for the tax law changes. Remember that some of the changes in the TCJA are temporary, and make sure that evaluators are accounting for the temporary nature of those changes. Keep in mind too that the TCJA only impacts federal taxes; state corporate taxes (where they exist) are generally unchanged. More than ever, the time may be right to hire your own expert to critique a neutral evaluator’s report!

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Karen Platt

Karen Platt is chair of the ABA Family Law Section Committee on Marital Property. As of July 1, she will be a partner with Pryor Cashman LLP.