In December, President Trump signed into law sweeping changes to the U.S. tax code. The centerpiece of the law is a lowering of the corporate tax rate.
In addition to changing tax rates for individuals and creating a special deduction for small businesses organized as pass-through entities, the law:
- Establishes a 21% flat tax rate for C-corporations, which impacts approximately one-third of Big “I” members.
- Enables a significant portion of the two-thirds of Big “I” members organized as pass-through entities (such as S-corporations, LLCs and partnerships) to utilize a 20% deduction on business income earned from the agency, subject to limitations.
- Reduces individual rates by one to four percentage points across six of the seven tax brackets and almost doubles the standard deduction, while instituting stricter limits on itemized deductions.
These changes directly impact every taxpayer in the U.S., but may also impact agency valuations, agency operating structure, and merger & acquisition activity.
According to an analysis by Reagan Consulting, a firm that advises independent agents and brokers, insurance agencies currently organized as C-corporations, as well as smaller pass-throughs in states with low income tax rates, are most likely to see increased valuations. However, because taxes for pass-through entities are based on every owner or shareholder’s individual tax picture, it is impossible to determine general impacts with certainty.
The analysis also notes that the new tax law will likely have a minimal impact on larger pass-through insurance agency valuations, and that converting to a C-corporation may or may not be beneficial because in most cases it still costs less in taxes to get cash out of a pass-through entity than a C-corporation.
In addition, several S-corporation benefits have not been affected by tax reform, such as allowing for an asset purchase structure in a third-party transaction, which can lead to more aggressive valuations from buyers. However, for agencies that do not distribute significant profits to owners, the C-corporation structure may be advantageous, as it enables them to retain significantly higher amounts of post-tax cash.
Reagan Consulting does not expect any dramatic changes to M&A rates due to tax reform.
Since 1993, Reagan Consulting and the Big “I” have partnered to produce the Best Practices Study, a comprehensive examination of the top-performing agencies across the country.
For more information, Big “I” members can log in to the Big “I” Taxes webpage, which the government affairs team will continue updating as the new tax law is implemented.
Jennifer Webb is Big “I” federal government affairs counsel.