In providing valuations for clients for a variety purposes, including financial reporting or estate and gift tax planning engagements, preparers should consider the impact on value of both State and Federal tax-related provisions. Tax provisions are frequently changing, whether it be due to a change in the Presidential administration or due to significant events such as COVID-19, and it is incumbent upon preparers of valuations to understand and appropriately implement these ever-changing tax rules.
Take the Tax Cuts and Jobs Act of 2017 (the “TCJA”), signed into law during the Trump administration, overhauled the Federal tax code through reforms for both individuals and businesses. Features of the TCJA which impacted businesses included:
- Lowering the corporate income tax rate from 35.0% to 21%
- Removing the carryback period for accrued net operating losses (“NOLs”) however allowing for an indefinite carryforward period for NOL’s at an amount equal to 80.0% of each subsequent year’s taxable income
- Limiting the amount of net interest a business could deduct against taxable income
- Amending Section 168(K) of the tax code to allow for accelerated cost recovery (“bonus depreciation”) for certain qualified property, and v) amending Section 174A of the tax code to require research and experimental (“R&E”) expenditures, including software development costs, to be capitalized and amortized over a five-year period beginning in tax years after 2021
Each of the above features of the TCJA should be considered by valuation analysts in preparing valuations for a variety of purposes, if applicable.
A recent bipartisan tax bill, agreed to by Senate Finance Committee Chairman Ron Wyden (D-Ore.) and House Ways and Means Committee Chairman Jason Smith, (R-Mo.) addresses the provisions set forth in the TCJA related to bonus depreciation on qualified property expenditures and R&E expenditure amortization, among others.
Specifically, H.R. 7024 or the Tax Relief for American Families and Workers Act of 2024 (the “Families and Workers Act”) would extend the 100% bonus depreciation feature for qualified property placed in service through January 1, 2026 before bonus depreciation would decline to 20.0% of qualified property placed in service prior to January 1, 2027. Currently, per the TCJA, for qualified property placed in service in calendar years 2023, 2024, 2025, and 2026, the applicable percentages are 80%, 60%, 40%, and 20%, respectively. This adjustment to the bonus depreciation levels allowed on qualified property expenditures would impact tax depreciation levels considered within discounted cash flow analyses prepared by valuation analysts. The increased depreciation provides a tax benefit that results in increased net cash flows and therefore an increase in values determined through discounted cash flow analysis.
Further, the Families and Workers Act would amend Sec. 174A of the tax code by:
- Delaying the amortization of domestic R&E expenditures to apply to expenditures paid or incurred in taxable years beginning after December 31, 2025
- Reinstating expensing for domestic R&E expenditures
Sec. 174A would be amended such that taxpayers would be allowed to deduct any domestic R&E expenditures paid or incurred during the taxable year or, at the election of the taxpayer, charge such expenditures to a capital account and be allowed to amortize deduction of such expenditures ratably over a period of not less than sixty (60) months as selected by the taxpayer. Therefore, the amendment would provide businesses with the ability to expense or capitalize and amortize domestic R&E expenditures. Currently, when reviewing operating forecasts prepared by management, valuation analysts should consider the impact of businesses needing to capitalize and amortize R&E expenditures for tax purposes (under the TCJA) versus fully expensing the costs in the period incurred. In general, the capitalization and amortization requirement results in a loss of a tax shield and reduction in after tax value that should be reflected in the analysis. Should the Families and Workers Act pass, however, valuation analysts would no longer need to separately consider this impact if it would be assumed the target company would elect to utilize the tax shield.
The Families and Workers Act was approved by the House Ways and Means Committee on January 19, 2024, and now heads to the House floor. Preparers of valuations should remain aware of movement of the Families and Workers Act through the legislative process given the impact certain of the proposed amendments to the tax code could have on business valuations, particularly within discounted cash flow analyses.
Bottom Line
Evergreen Advisors’ team of business valuation professionals monitor proposals to changes to the U.S. tax code similar to the amendments proposed above to stay at the forefront on rising issues and best practices in engagements for both financial reporting and estate and gift tax purposes. Our team provides valuations that are required to support GAAP (“Generally Accepted Accounting Principles”) based financial statements, including purchase price allocations (business combinations), testing for goodwill impairment, investment portfolio valuations, and equity-based compensation, and to support estate and gift tax filings related to planning exercises.
