Not All Businesses Benefit the Same Under Trump’s Tax Proposal

 In Trump tax proposal

Since Donald Trump was on the campaign trail, he has been promising companies a “huge” tax cut.  However, not all businesses are likely to benefit equally.    Small and midsize organizations stand to gain the most from a straightforward corporate tax cut, though only if they are actually profitable.  This data is according to interviews of members of Bloomberg’s Breakaway network, which consists of 78 well known high growth companies with annual revenue averaging around $400 million.  

house-blueprint-tax-reformTrump’s administration has proposed reducing the maximum tax rate from 35% to 15 %.   Now, House Republicans favor a 20% rate and also want to lower the top rate for so-called pass-through entities, which is a category that includes LLCs and S-corps, from 39.6% down to 25%.   More than 90% of U.S. businesses– comprising an aggregate of 28.3 million – are considered pass-throughs, and most are small to midsize.  Under Trump’s plan, the 15% tax cut rate would apply to such establishments.  Keep in mind that this could benefit Trump’s own former businesses, which are also structured as limited liability companies (LLCs).      

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One important issue to keep in mind: only profitable businesses will see any advantage from a tax cut to the corporate rate- and that is more likely to be mature enterprises than startups.   But also keep in mind, that only profitable businesses’ ever stands to immediately gain from tax cuts because a revenue loss is rarely taxed.  Among publicly traded companies, 82% of mid-caps were profitable in 2016, vs. 68% of smaller organizations, according to FTSE Russell, which compiles various stock indexes.

“I know companies like our’s will not benefit from President Trump’s proposed tax breaks,” says Matt Potts, startup entrepreneur and founder of ArchPort Technology Solutions, a market patented wearable consumer products E-commerce company founded in 2006. “We’ve been investing heavily in building new products and creating jobs for the past decade,” he says. “Because of these heavy investments, we have past losses that we can use to offset taxes for quite a while.”  This is a very good example of a potentially great company that, initiated as a startup, is still growing but because of lack of profit, will not see a tax break.  

The Republican House plan would eliminate the deduction for interest payments by businesses, a provision Trump has used in the past, according to the limited public information about his tax returns.   The proposal, that the U.S. Secretary of the Treasury Steven Mnuchin unveiled on April 26, 2017 did not mention any details on the future of that deduction.  “Many midsize and smaller companies don’t have access to the capital markets to the same extent large companies do,” says Bob Witt, founder of Witt CPA. “They have to go out and get debt to grow sometimes” and without the interest tax deduction, their financing costs would be much higher.      

proposalEnterprises with international business operations often hide or park profits abroad to defer U.S taxes.  It is a common thought that this strategy was made to induce these businesses to bring that money home, so to speak.   The trump plan offers a “tax repatriation holiday,” which he and Paul Ryan, Speaker of the House, originally proposed at a rock-bottom tax rate of 10%; the House GOP plan recommends rates as low as 3.5%.  Clearly, the final details need to be ironed out if they are to become legislation.     

“We’ve got offshore earning for sales out of our Beijing operation,” says Robert White, a Sales Manager at Soule, Blake and Wechsler (SBW), a global manufacturer of OEM and custom engineered components based in Stamford, Connecticut.  “If we were to bring those profits back into the U.S., they would be taxed at 35% instead of Beijing’s 16.5%.”  White says Soule, Blake, and Wechsler are pursuing a possible acquisition outside the U.S. With the $5 million in cash it expects SBW to have by year-end from its international manufacturing operations.  That said, White states that if his respective company would strongly consider expanding at home if the U.S. Tax code became more forgiving and flexible with domestically owned businesses.    

Republican congressional leader, Paul Ryan, Speaker of the House, and Texas Representative, Kevin Brady, chairman of the House Ways and Means Committee, both want a border-adjusted tax to pay for potential corporate tax breaks.  If enacted, this would disallow operating-cost deductions for profits made from imported goods, while allowing a full deduction for all domestically produced products. This would also favor startups and midsize businesses because they are more domestically oriented, and benefit exporters while penalizing importer.  Larger enterprises that would be penalized could be, in particular, companies like Wal-Mart Stores, Inc. Or Target… Basically, enterprises that primarily sells foreign manufactured goods.   

So, despite calls for a more simplified tax code have emerged from many quarters,  entrepreneur and co-author of The Startup Owner’s Manual, Bob Dorf, says there’s a need for nuance.  “When people think about tax policy as related to business, they think about it in too much of a one-size-fits-all kind of perspective,” says Dorf, now an instructor at Columbia Business School. “ The reality is, there are three different sectors.  The big businesses are thinking about global taxes and profit repatriations.  Small businesses as represented by the U.S Chamber of Commerce are often thinking about simplifying regulation and minimizing taxes. But the real place to focus if you want to improve job creation is on younger, high-growth startups.”      

According to data compiled by the Ewing Marion Kauffman Foundation, businesses less than five years old were responsible for almost all net job growth in the U.S. From 1988 to 2012.  Those less than one-year-old is the most important, creating a total of  1.5 million jobs each year.  However, startups are heavily concentrated in a few places. “Last year, 78% of venture capital went to just three states- California, New York and Massachusetts,” Dorf says.  To spread the wealth, he prescribes targeted tax breaks for startups outside of those states with pre-existing incentivizes aimed to generate job creation in the startup/young business sector.   

But, some provisions in the White House tax proposal may wind up hurting job-generating young companies.  On the campaign trail, Trump called for the elimination of tax breaks for “carried interest”.  Carried interest is the profit that accrues to an entity’s principal’s in private equity, venture capital, and hedge funds; carried interest is currently taxed at only 20%.  This is despite the fact that private equity and hedge funds do much more to drive or spark new job growth than venture capital firms do. “Maybe there should be no tax on small and regional venture capital firms with $20 million in funds in places like Albuquerque, New Mexico, while there should be higher taxes on hedge funds, private equity firms, or large venture capital firms that only invest in NYC or Silicon Valley,” Dorf says.      

Conclusion   

We still need more details and it’s still too early to know if the tax plan would be revenue-neutral,  and would the cuts expire the within a decade? And it didn’t take a position on revenue-raisers that House Republican leaders have proposed, including a border-adjusted tax on imports and domestic sales.   President Trump’s proposal to cut the federal corporate income tax rate to 15% from 35% could mean a windfall for many industries with a domestic focus, including retailers, telecom companies, regional banks, restaurant chains, and health insurers.  

The bottom line: Midsize businesses and pass-through entities will get the biggest bang from Trump’s proposed tax plan.

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