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The Effects of the 2017 Tax Cuts and Jobs Act on Valuations of Businesses

June 20, 2018

Howard Fielstein, CPA/ABV/CFF, ASA

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As many of you know, the Tax Cuts and Jobs Act (TCJA) has created many changes in the taxation of income and deduction of expenses for individuals and business entities.  These changes have created a myriad of issues to be considered in the valuation of businesses.  The following is a brief summary of some of those issues.

The income approach will likely be the most impacted by the TCJA based on the effect on cash flows and discount rates.  The cash flow analyses would need to be adjusted for the changes in tax rates and the ability to immediately expense certain purchases of fixed assets, among others. 

All things being equal, the cuts in corporate tax rates from 35% to 21% should raise the valuation of C Corporations (C Corps) and S Corporations (S Corps).  Of course, how a corporation uses the tax savings will impact the extent of the change in value, if any. 

The fact that the tax impacts effect will possibly be felt throughout the entire economy could impact the macro and micro economic effect(s) in the valuation analysts’ assessment of risk which directly impacts discounts rates, etc. to be utilized in application of the income approach.

One of the key inputs for the calculation of the pass through deduction is owner’s compensation.  This will put additional emphasis on the concept of reasonable compensation for S Corps.  As many of you know, there has been an ongoing desire for S Corp owners to minimize owners’ compensation to reduce self-employment taxes.  This would be expected to maximize the Qualified Business Income (QBI) deduction, which is subject to a 20% deduction.  However, there is now the competing desire to increase owners’ compensation so the QBI deduction is not limited.  This will put the reasonable compensation issue on the radar of the IRS for both the taxation and valuation of S-Corps.

The new tax breaks for S corps (e.g. 20% deduction) may reduce or eliminate the benefit of being an S Corp vs. a C Corp for at least valuation purposes.  However, there are many intricacies to be considered so this will need to be examined on a case by case basis.  In fact, under certain scenarios, an S Corp could be worth less than a C Corp if the pass through entity does not qualify for the QBI tax deduction.

The market approach utilizing the guideline public company method will be affected by the change in stock prices and the resulting changes in pricing multiples. 

It is not expected that there will be any impact on the discounts for lack of marketability or lack of control due to the TCJA.