Tax Reform Brings Big Changes

The Tax Cuts and Jobs Act of 2017, which slashed the corporate tax rate from 35 percent to a flat 21 percent and repealed the corporate alternative minimum tax, has created both short-term and long-term growth opportunities for many Colorado middle market businesses.

The act boosts corporations’ after-tax profits and gives businesses some fiscal breathing room, which many are using to boost employee compensation or make significant capital investments in their business. It also paves the way for expanded merger and acquisition activity, with middle market businesses considering growth through acquisition or preparing their business for sale.

EMPLOYEE BENEFITS

One-time bonuses were an immediate – and high-profile – employee benefit prompted by tax reform. But many businesses are also considering other, longer-term changes to employee benefits. According to a recent Willis Towers Watson survey, middle market businesses are considering boosting personal financial planning services they offer employees, increasing (or establishing) a company 401(k) match or adding a new paid family leave program. Survey highlights show:

• 66 percent of respondents are planning or considering making changes to their benefit programs or have already taken action.
• The most common changes organizations have made or are planning or considering include:
  • Expanding personal financial planning (34 percent)
  • Increasing 401(k) contributions (26 percent)

Other options included reducing the employee payroll deduction or adding a new paid family leave program in accordance with the Family Medical and Leave Act's tax credit available for paid leave for certain employees.

Competition for top talent might be the lead driver for middle market businesses now evaluating the benefits they offer. Apart from the ongoing pressure created by a steadily growing job market, middle market businesses that plan to expand see adding employees as the first step, according to the most recent KeyBank Middle Market Business Sentiment survey.

CAPITAL INVESTMENT

A smaller corporate tax bill might give middle market business owners new appetite for capital improvements, either by expanding facilities or adding equipment, including new technology. In fact, a recent KeyBank Middle Market Business Sentiment survey showed 54 percent of middle market leaders participating in the survey expect to spend more on technology in 2018.

Whether your business is considering an investment in technology or other types of capital equipment, an analysis of your needs and options can help shed light on the impacts of tax reform on equipment finance.

For example, Section 179 has traditionally allowed businesses with limited capital acquisitions to expense 100 percent of the cost of new and pre-owned equipment in the first year of ownership. Owners could expense up to $500,000 in cost, so long as the business’s total equipment investment for the year did not exceed $2,000,000. For investments totaling more than $2,000,000, the deduction declined on a dollar-for-dollar basis.

The Tax Cuts and Jobs Act permanently increased the deduction to $1,000,000 beginning in 2018, on an equipment investment limit of $2,500,000. Section 179 has always applied to new build and pre-owned equipment purchases – previously a significant distinction from bonus depreciation which was only allowed on new equipment. However, the new tax reform changes to Section 179 are both permanent and now applicable to a broader set of assets, including HVAC and ventilation systems, fire protection and security systems.

Bonus depreciation is another area that has seen massive changes under the new tax laws. For the better part of the last decade, bonus depreciation has reigned supreme, offering an additional 30 percent to 50 percent cost recovery – in addition to standard MACRS depreciation – on new equipment in the year it was placed in service. For equipment placed in service after September 27, 2017 and before January 1, 2023, however, the tax reform bill now allows those who invest in qualified equipment, both new and used, during that time to depreciate 100 percent of the equipment cost in the first year of ownership.

This unprecedented benefit is a huge windfall for businesses with sufficient taxable income to claim it. That said, the benefit of such a write-off has less impact in a 21 percent corporate tax environment than in a 35 percent tax environment; therefore more businesses might be unable to absorb all the depreciation benefits available to them. In addition, new limitations on the deductibility of interest expense on debt will offset some of the benefits of the increased 179 expense or 100 percent bonus depreciation. As a result, even full taxpayers could now find that a tax lease allows them to monetize otherwise unused depreciation benefits, maximize the interest expense deduction, and therefore provide the lowest after-tax cost to acquire equipment.

M + A CONSIDERATIONS

Better cash flow might also drive more middle market businesses to expand through acquisition, particularly targets that, due to the new tax law, require or produce accelerated tax benefits for what the law terms “qualified property,” which now includes equipment acquired in the purchase. The act defines qualified property to include any tangible property with a depreciable life of 20 years or less. Examples of qualified property include computer software, machinery, land, property and other tangible assets.

Tax reform is also expected to make for a strong sellers’ market, which means middle market business owners should revisit their exit strategies. That starts with keeping a close eye on three salient elements:

1. Equity and debt capital so buyers can borrow at favorable rates
2. Strong market conditions
3. Ability to demonstrate potential future market growth.

Next, business owners should take steps to make their company as attractive as possible by cleaning up financials, inventory and receivables and showcasing a strong client experience. While buyer due diligence might start with assessing financials, inventory and receivables, a business’ long-term value rests with clients who benefit from a great client experience, and so are willing to bring more business to the company, and recommend the company to others.

Whether your company is considering increasing employee benefits, acquiring new equipment, or seeking out a merger or acquisition partner, now is a good time to consult with your company’s tax and finance partners. The Tax Cuts and Jobs Act brings big changes, and with it, big opportunities for those who are strategic about investing in growth.

Doug Dell is senior vice president and manager of KeyBank’s Colorado Commercial Banking Group. He can be reached at [email protected].