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Valuation Implications of the Tax Cuts and Jobs Act of 2017
The Tax Cuts and Jobs Act of 2017 (TCJA) was signed into law by President Trump on Dec. 22, 2017. The President referred to the legislation as the biggest tax cut in American history, with substantial reductions in both corporate and personal income tax rates. Whether or not that holds true, it is by far the most significant income tax legislation since 1986, when the passive activity rules were first enacted.
The TCJA will have significant impact on the value of Subchapter C corporations, as well as pass-through entities and the owners thereof. This article focuses first and primarily on the impact of tax reform on C corporations. Second, it looks briefly at the significant and complex changes to pass through entities, which include Subchapter S corporations, limited liability corporations and partnerships and sole proprietorships. This latter pass-through taxation aspect will dramatically change the tax landscape for the owners of these pass-through entities as they assess the impact of the TCJA on their individual income tax obligations.
Corporate Taxes are Lowered
With the election of Donald Trump in late 2016, the public markets began to anticipate that he would follow through on one of his primary campaign promises to cut business taxes in order to make American corporations more competitive on the world stage.
Provisions within the TCJA allow for the repatriation of global profits by U.S. corporations that already has seen companies like Apple announcing the return of hundreds of billions of dollars to domestic accounts and domestic investment that previously had been sheltered in other countries with lower corporate tax rates. The key question is how this and other aspects of TCJA will run up in public market freely traded equity values. Will those increased values be sustainable and, more importantly in the context of this article, how does all this change translate into the value of closely held businesses?
Basic Valuation Equation
Let's revisit the fundamental equation of valuation. It can be stated two ways, based on a market based perspective or income based perspective:
Value = Earnings x Multiple
Value = Income/Risk – Growth
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