While much of the rest of the U.S. business community is celebrating the new tax law, owners and executives at certain California businesses are groaning and scrambling to talk to their tax experts.
Chapman University economist Jim Doti predicted the law may cause the highest effective tax hike in the state’s history because of reductions in the permitted amounts on federal returns of state income and property tax deductions.
The Business Journal’s Peter J. Brennan sought the opinions of three chief financial officers on the reform, which President Donald Trump signed on Dec. 22.
We asked them to discuss whether the tax reform gives them confidence about their company and the market’s direction; about their favorite and least favorite parts of the law; how the new tax rates will affect their business; and the most important questions they’re asking their tax experts.
Here are edited excerpts of their responses:
Karl Hardesty
CFO, CEO
Hardesty LLC
It’s really interesting being queried on tax planning at this time of year with the new legislation just being passed. Obviously, this is the biggest tax reform since 1986. I have been monitoring the legislation as it affects my business, as well as every Hardesty client’s business in a major way. Hardesty, which is an executive recruiter of CFOs and other C-level executives, is a pass-through entity, as many small businesses are.
The gift we were given was relative clarity and eventual passage prior to the end of the calendar year. That gave every CFO, business owner and individual a few days to make some critical decisions. So we at least have some clarity on the new tax rates for both individuals and corporations. The good news is they are all down.
The big news is the dramatic drop in corporate tax rates from 35% to 21%.
Many of our clients are cash-basis taxpayers versus accrual basis taxpayers. That allows some flexibility to accelerate certain deductions that companies would normally pay in 2018 and some flexibility on recognizing revenues. Since tax rates are generally going down, basic logic would be to accelerate expenses and defer revenues, since the value of a deduction was higher in 2017 than in 2018 and revenues will be taxed at a lower rate in 2018.
If you run a business that renders services and operates on a cash basis, the income you earn isn’t taxed until you are paid. You may have considered waiting to bill until this year or until a time when there is no chance you will receive the cash for 2017.
As for expenses, we looked hard at everything related to 2017 and attempted to have them paid prior to Dec. 31. Those included:
• Pension matching contributions normally paid in March.
• Certain bonus payments; even if the final numbers can’t be finalized, an estimate is made and paid to the employee.
• Certain prepaid rents could be deductible.
• Certain fixed assets purchased after Sept. 27, 2017, can be fully deducted rather than depreciated in 2017. That rule is good through Jan. 1, 2023. I just took advantage of this by purchasing some assets last month so I get the 100% write off in 2017.
• Certain bonus payments we make to our staff are contingent on collections. In some cases, we made those payments in 2017, even though collections are expected in 2018.
I would highly recommend that all CFOs spend some time early this year with their tax advisers to fully understand the implications of the new law. There are some complex items that will require interpretation from professionals.
Diane Peck
CFO
Beacon Pointe Advisors
As an LLC in the financial services industry, we won’t directly benefit from the tax cuts for businesses, as we don’t benefit from the favorable 21% corporate tax rate, nor will we get much benefit from the 20% deduction for pass-through qualified business income, given our status as a service provider.
The most notable impact to the financial advisory industry may be the boost to corporate earnings, which we know drives stock prices. It’s important to note, however, that much of the corporate tax relief and the consequent boost to earnings has been anticipated and is already priced into today’s valuations. The tax reform should continue to provide some tail wind to stock prices in 2018, but stock valuations are already stretched, and the further the market is stretched, the more susceptible it is to surprises. Surprises produce market volatility. We would expect a higher stock market with more volatility in 2018.
We appreciate the reduction in federal income tax rates, but our appreciation is tempered by the loss of the majority of the deductions for state and local taxes. We’re also pleased to see the doubling of the gift and estate tax exemption amount to allow many clients that worked hard to build businesses and family wealth to be able to pass that wealth to heirs.
As California residents, the elimination of the state and local tax deduction for all but $10,000 of taxes between income tax, property tax and sales tax means many in California will see taxes increase despite the lowering of federal income tax brackets.
We are asking our tax experts what steps we can take to help our clients seize on opportunities, such as whether it makes sense to convert to a C-corp, and under what circumstances, given anti-abuse provisions of the new law.
We expect to continue to help clients invest to meet their life goals, understanding the impact of this new tax regime by reviewing their financial and estate situations.
In anticipation of the loss of the deduction for state income taxes and the increased standard deduction, we have and will continue to work with clients to determine if it is wise to prepay any remaining 2017 state income tax liability in 2017, prepay 2017 property tax payments payable in 2018, or set up a donor-advised fund to support charities in the future if they believe the increased standard deduction makes it unlikely that they will itemize after this year.
David Woodruff
CFO
MVE & Partners
MVE & Partners is considered an S Corporation, a pass-through entity, which means we currently pay taxes at the higher individual rate. The legislation changed the pass-through income tax rate to 25%, but unfortunately it excludes professional service firms from accessing the lower rate. Big corporations will be the real winners, and MVE will see very little direct benefit. That being said, there will be indirect benefits.
I don’t think it comes as a surprise that our counterparts in the commercial real estate industry will fare well under this plan. Provisions that could significantly benefit the commercial real estate industry include lower tax rates for corporations and pass-through entities, broader provision for expensing depreciable business assets, and more accelerated cost recovery schedules. The lack of change to carried interest treatment or tax deferral for certain exchanges of commercial property will also benefit the industry. The strength of that market segment and the construction industry in general are key to the economic health of many industries across the nation, including architecture.
I believe a territorial system combined with the lower corporate tax rates will stimulate productivity and economic growth in the U.S. Previously, the U.S. had a system of worldwide taxation and one of the highest corporate tax rates in the developed world. The system provided no incentive to invest domestically, and it created a huge disadvantage for U.S. firms to compete abroad due to the tax on foreign income. A tax repatriation holiday rate of 15.5%, and a territorial system with reduced corporate tax rates, should provide sufficient incentives to bring offshore profits home and encourage domestic investment. A growing economy is good for our business.
Everything considered, the lower individual tax brackets are my favorite part, but there are parts of this law that can impact our community negatively. The proposed legislation does not favor residential homeowners, particularly those living in expensive metropolitan areas. Mortgage interest and state and local tax deductions, which are two of the most popular itemized deductions, will be limited and/or repealed all together. How it will affect you depends on your housing market.
In Orange County, where we have much higher house values and property taxes, the law is going to have a significant negative impact.
