By: Carl Koerner
The Tax Cut and Jobs Act of 2017 (TCJA) is the most comprehensive restructuring of the tax law in over 30 years. For anyone in business today, it is likely that the law will include both tax gains and tax losses. In order to optimize the tax benefits of the new law, and minimize the tax burdens, business leaders have begun to rethink how their businesses are organized, capitalized and structured. The immediate “knee jerk” reaction is to think tactically. Should we switch to a pass through entity? Is it better to be taxed as a “C” corporation? But that type of narrow analysis is a lost opportunity. A better New Year’s Resolution is to use this legislation to encourage deeper analysis and strategic thinking.
A lesson can be learned from the huge effort to incorporate computers into the business environment following WWII. Some companies focused on using the new computers to replicate their business process. Others chose to think strategically. First, they documented their business processes and analyzed them. Often they found bureaucratic complexity and bloat. Systems analysts found the proverbial seven-part form which traveled throughout the company to many locations, where it was never read, but dutifully filed away for posterity. Next, they streamlined and rationalized those processes to make them as efficient as possible. Only then did they begin to write programs for the new computers. During this period, the United States experienced one of the strongest periods of productivity growth. But interestingly, the greatest benefit of that growth wasn’t from the processing speed of the computers, but instead came from the more efficient business practices adopted by management.
Here is how to apply this same approach now:
- Start with a clear understanding of your business objective. Is it to realize value through a sale or other transaction? Or, are you building a legacy institution that can benefit you, your family and loyal employees over a long term? With that understanding analyze your business as if you were forming it today.
- What is the ideal business entity to serve your objectives: a C corporation, an S corporation, an LLC, a limited partnership, a business trust? Which entity type is best suited for maximum tax efficiency and flexibility? How will that business entity help you achieve your goals?
- Laws vary from jurisdiction to jurisdiction. As you consider your objectives, take into account the differences. You have 50 states and many foreign countries to choose from.
- Are there important reasons to segment the business into multiple entities? Are there regulatory concerns, risk exposures to contain, tax implications or financing requirements? Alternatively, are there reasons why multiple entities no longer make sense and a consolidation of business enterprise might be more efficient and less costly?
- What are the current and future capital requirements for the business? The TCJA has taken some of the fun out of leverage with its limitation on deductible interest. Does that make a difference?
- What should be the role of debt, equity, and other methods of finance such as equipment leasing, or receivable financing? How should you incentivize all of your capital participants so that there is an alignment of interests tailored to your objective? What would be the balance sheet of this ideal company?
- How should your company invest in human capital to build and grow the enterprise? Where is the proper balance between your business needs and those of your team members? When should you use employees, independent contractors, service companies, or foreign resources? How can you take advantage of machine learning and artificial intelligence?
The Tax Act is far-reaching and will have broad implications for everyone in business. One choice is to react to it. But the better long term value will come from using this opportunity to disrupt the pattern of day-to-day thinking. You will gain important insights that can transform your business.
What better time to think strategically than at the start of a new year?
Best wishes for a healthy, happy and transformative new year.