As we pass the COVID-delayed Tax Day, we thought it would be a good time to remind you to review your corporate structure to see if you are best positioned to reduce your yearly tax burden, and to better understand the tax liability you will face when you eventually sell your agency.
Passed in 2017, the Tax Cuts and Jobs Act went into effect in 2018. The new law had specific implications for independent insurance agencies, depending on how their business is organized.
Agencies organized as C-Corps, there was a substantial cut to the corporate tax rate, which was lowered from 35% to 21%. These tax cuts are permanent.
Agencies organized as pass-through entities (S-Corps, Partnerships, LLCs, Sole Proprietorships) also received favorable treatment in the revised tax code. The new law provides a 20% deduction of their qualified business income on their taxes, regardless of their income level. This law remains in effect until 2025 unless Congress acts.
When you are looking to sell your agency, your corporate structure is the key determinant that drives the deal toward a stock or an asset purchase.
During a stock sale, the seller receives capital gains treatment on the proceeds. Meaning, the amount of time that the stock was held before being sold determines its capital gains for tax purposes. Additionally, the seller leaves all of the agency’s liabilities, known and unknown, and contractual relationships with the entity, which is a disadvantage to the buyer.
During an asset sale, the buyer acquires all of the intangible assets and most of the tangible assets from the agency but avoids inheriting the liabilities of the agency. Buyers, in general, prefer asset deals, whereas sellers prefer stock deals.
Additionally, there are tax implications tied to whether it is a stock or asset sale. In an asset deal, the tax-advantages of capital gains income are not realized in a C-Corp. Proceeds from the sale paid to shareholders are not tax deductible to the corporation, but to the stockholders, as double taxation.
For an S-Corp, there is no double taxation as the proceeds from an asset sale pass-through the agency to the individual owners, where tax is paid at their personal rate.
WHAT IS RIGHT FOR YOUR AGENCY?
OIA recommends that its members consult their accountants, attorneys, and consultants to determine how they will be affected by the tax code based on their individual circumstances. The right professionals can help you do scenario planning to discover the best option for your agency now, and for when you retire.