Taxes Create Perpetuation Predicaments

Independent agents face many challenges in running their businesses, including market cycles, efficient use of technology, employee recruitment and retention. Thanks to soon-to-sunset tax legislation, another concern is rapidly ascending the list: Agency perpetuation.

According to the Big “I” Agency Universe Study, the average age of an agency principal is in the mid-50s, regardless of the size of the agency, and 40% of all agency principals are age 55 and older. This means that a substantial portion of independent agencies will be dealing with perpetuation issues in the coming decade. And while this fact might be seen as part of a demographic cycle, there also is a continuing trend of fewer independent insurance agencies—from 44,000 in 1996 to 37,500 in 2006—and the average agency size is increasing.

There is another dynamic that agency principals must consider as they gauge their perpetuation plans: Taxes. The old adage that nothing is certain but death and taxes is true, but it requires clarification. While we can always count on paying a variety of taxes, the rate of tax fluctuates greatly depending on the needs of the country (income taxes soared during World War II) and the philosophies of the political parties controlling Congress and the White House. Agency principals encounter a number of taxes, including income, payroll, capital gains and estate.

The last significant piece of tax legislation was 2001’s Economic Growth and Tax Relief Reconciliation Act, which lowered income, capital gains and estate taxes. But since the vote to pass this legislation had less than 60 votes in the Senate, under the Byrd Rule, it is destined to sunset in 10 years unless it is renewed. While some aspects of the law have been made permanent, the estate tax and income tax provisions are set to expire in 2010 (along with the lower capital gains rate, which Congress extended to 2010). This will result in increases in both taxes as they revert to the pre-2001 levels.

Given the current composition of Congress, it is highly unlikely that there will be substantial tax legislation to offset the reversion before the next presidential election. And, the economic climate is very different now than it was six years ago when the federal deficit was significantly less and the country was not at war. Presumably, Congress will focus on trying to restore some of the provisions of the 2001 law regarding the “marriage penalty” and the Alternative Minimum Tax (AMT) exemption, which can end up disallowing deductible state and local taxes and other deductions even for middle-class income taxpayers. While it’s hard to precisely forecast what will happen, it is very likely that the capital gains rate will revert to the 20% capital gains rate of pre-2001, and it is possible that the top end of the capital gains tax could increase to 25% and 28%. Coupled with lower estate tax thresholds, this would make it difficult for agency principals to avoid the unrealized gain on the value of their agency by passing it to their heirs at death where they would receive the step-up in basis in the value of the agency stock.

What are the implications for the insurance industry? Uncertainty about the outcome of the tax laws might motivate agency principals to consider selling their agencies in order to take advantage of the current capital gains tax rates. Many carriers that rely on the independent agent channel are concerned that they will have fewer outlets for their products. Regional carriers are particularly nervous because they fear that agency principals may sell to larger agencies/brokers, banks or others that are not as loyal to the regional carrier.

The Big “I” has been following this situation and decided almost a decade ago to start and invest in a new bank—InsurBanc—that pro¬vides perpetuation loans to agencies to help finance perpetuating the agency from within. The Big “I” also continues to be politically active in lobbying Congress by working with other business groups to have sensible tax legislation that encourages the formation and continuation of small and medium-sized businesses.

It’s important for Big “I” members to communicate with and vote for candidates who understand the importance of having reasonable tax policies that encourage entrepreneurs to take the risks of starting and maintaining businesses that, in turn, support job creation. Agents need to be politically active and involved to help shape the outcome at this critical tax legislation juncture, and the Big “I” will be there every step of the way to assist on Capitol Hill.

Bob Rusbuldt (bob.rusbuldt@iiaba.net) is CEO of the Big “I.”