How has the Tax Cuts and Jobs Act (“TCJA”) affected business valuations? The impact of the TCJA is dependent upon the company being valued as well as the specific approach chosen for a valuation. Listed below are a few key items that should be considered when using an Income Approach to valuation and when valuing the entity as a C corporation.
- Change in After-Tax Earnings – Under the TCJA, the federal tax rate for a C corporation was permanently reduced from 35% to 21%. That should reduce taxes and increase after-tax cash flow, all else being equal, so if using historical earnings to value a company, make sure to account for this rate reduction. Also, update taxes to the new tax rate in any forecasts used in the discounted cash flow approach.
- Discount Rate – The reduction to the tax rate will also affect the weighted average of cost of capital (“WACC”), wherein the cost of debt is reduced by the tax savings benefit of interest expense. Therefore, the lower tax rate will increase the discount rate due to less tax savings from interest expense. Also, be aware of the limitation on interest expense deductibility of 30% of adjusted taxable income, as defined by the TCJA.
- Depreciation Expense – New allowances for depreciation need to be taken into account in any forecast of future income. In general, all qualified property purchased in 2018 through 2022 is 100% deductible in the year purchased. From 2023 to 2027, that percentage is reduced by 20% each year. So if using the discounted cash flow method, sufficient years of cash flows to account for this tax savings will need to be included in the forecasts or the tax benefit of the depreciation will need to be accounted for separately and added to the valuation.
Remember, valuation is not an exact science and requires astute judgment in determining the correct approach and assumptions. If you need help in determining the value of your company, please contact Christy Samek at 412-697-5415.