ATLANTA -- Donald Trump has formally announced one of the largest tax cuts that a U.S. president has ever made. The changes will have an effect on most American businesses, including convenience-store operators. Here’s a first-pass evaluation of how the 2017 tax-cut proposals may affect your business.
Before we jump in, it’s important to note that the details released about the plan have been high level. As more details are released and the traditional horse trading occurs in Washington, parts of the proposals will likely be updated or not become law. With that said, here are a couple of first-look takeaways.
New Tax Rates
President Trump plans to cut the 39.6% tax rate of pass-through companies to 15%. The changes are proposed for “corporations, small businesses and partnerships of all sizes,” according to a Bloomberg report. At the same time, the maximum personal income tax rate is proposed to be 35%, down from 39.6%. The number of personal tax rates would drop from seven tiers to three (35%, 25%, 10%) under the proposal. The effective individual tax rate may also be affected by the elimination of many current deductions, including state and local taxes, which may blunt the cuts in some high-tax states.
Changes to business tax rates make the use of “pass-through business” tax, which allows owners to move taxation to personal income from the company, unattractive. One of the key reasons that small businesses turn to pass-through business taxation is to prevent being taxed twice (taxed as a business and taxed for personal income).
One impact could be that owners of small businesses will take a smaller salary in order to save money in taxes. For example, let’s consider a store owner that generates $100,000 in net profit. In the past, the owner may have taken the entire profit and filed it as personal income to prevent being double taxed. With a proposed 37% tax rate on personal income, the owner would pay $37,000 in taxes. If Trump were to achieve the cut to 15%, the tax savings would be $22,000. A small-business owner may choose to take a much smaller personal income, say $10,000, and have the balance taxed at 15%.
Effect on Capital Depreciation
Currently, depreciation can result in a significant reduction in the net cost of capital equipment. For example, for a business in a 35% tax bracket, a $100,000 piece of equipment generates $35,000 of tax savings through the use of Section 179 or standard depreciation. Using Section 179 provides these benefits in the first year of ownership.
If the tax rate falls to 15%, the resulting depreciation benefit drops by $20,000 to $15,000. This has the effect of increasing the net after tax cost of the equipment from $65,000 to $85,000. It is unclear at the time of writing if Section 179 accelerated depreciation will continue, or be discontinued for either the 2017 or 2018 tax year. The Wall Street Journal reports that Trump’s plan leaves out several significant topics, including whether companies will be able to continue to write off capital expenses immediately.
Trump had been reported earlier as considering doubling the current $500,000 maximum for Section 179 to $1 million per year, according to AccountingWeb. If this proposal becomes reality it could be stimulative for spending and investment by multisite owners.
Stock Market Impact
The reduced tax rates may make investing in small-cap stocks more attractive. If the tax cuts are more beneficial for small companies than larger companies, it's likely we will see growth in earnings and potentially price/earnings ratios for small-caps. There are several changes proposed for large corporations that may result in earnings benefits for them, so at this stage the net effect is unclear and may shift. It is unclear how much of the "Trump bump" that we’ve experienced since the election is due to the promised tax changes, and consequently how much more upside the market has. A report by The Wall Street Journal from S&P Global Market Intelligence suggests that a 1% reduction in effective tax rates translates into increased earnings of $1.34 for the S&P 500.
Additionally, master limited partnerships (MLPs) may benefit as their effective tax rate shifts from the current personal rates of up to 39.6% to the proposed 15% corporate rate.
One conglomerate that may benefit from the tax cut is Warren Buffet’s Berkshire Hathaway Inc. According to Nicole Friedman of the Wall Street Journal, the book value of Berkshire Hathaway may increase by 13%, thanks to the 15% corporate tax rate.
Border Adjustment Tax
There has also been talk about a provision proposed by the House Republicans called the border adjustment tax, which many don’t believe Trump is willing to support. The border adjustment tax was not part of the Trump proposal but is a key piece of House Speaker Paul Ryan’s proposals. The border adjustment tax would effectively increase the cost of imported goods, including many popular c-store items.
The Bottom Line
At this stage, it would be foolhardy to project how much of the president’s proposal will become reality. It is prudent to stay informed on the progress of the proposals, and to take action where the potential changes may affect your business for the worse, such as in the area of capital depreciation.
- Click here to read Economist Sees Good News for C-Stores in Trump’s Agenda.
Richard Browne is vice president of marketing for Patriot Capital, Atlanta. Reach him at richard.browne@patcapfinance.com.
The opinions in this article are the personal opinions of the author and do not represent opinions or advice of Patriot Capital or State Bank. This article is not intended to provide tax or legal advice, please consult your tax and legal professional advisors for advice regarding your particular situation.
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