By Jarrod Musick, Client Wealth Strategist, CFP®
"The only constant in life is change" - Heraclitus
A global pandemic upending the rhythm of our day to day life feels huge. What happens next may be bigger on the financial side for business owners. As things change, our opportunities to adapt and take advantage must evolve. We expect a number of new opportunities and challenges for business owners in the next year.
Our top 3 business owner variables in 2021
(If you haven’t already, please listen to our podcast with Sarah Earhart where we discuss how changes to tax policy, interest rates, and asset prices create different opportunities and challenges over time.)
So, assuming that we are correct about the changes in those three variables, what should we do about it as business owners?
Low Interest Rates
This is not a change but a continuation of what we have seen since March of 2020. Low interest rates broadly decrease the cost of capital and influence lender behavior. Your ability to acquire new assets, purchase or refinance business real estate, and borrow should remain high. Lenders are very risk averse currently and for loans that have to be carried by the institution themselves, non-SBA or other government guaranteed programs, have been getting more difficult to come by. We have also seen this in the jumbo mortgage space as lenders have been seeking higher down payment amounts and more assets on deposit to underwrite the loan.
TL;DR - If you need to borrow for the long term and have cashflow and cash reserves, now is a great time. Lenders may be reluctant to lend, so expect some time needed to find the right loan.
Tax Rates Moving Higher
We are always dubious to write about tax policies before the votes are taken in Congress but the consistent message from the Biden campaign was that income tax rates and capital gains tax rates above a certain threshold would be higher. The message was also clear that corporate tax rates would move broadly higher but below what they were prior to 2017. Corporate tax rates present challenges that are best addressed on a business by business level and we will not speak to them here beyond setting the expectation that things like carried interest and net operating losses seem to be set to be retained. On the individual tax and pass-through entity side there are several large changes we expect to see. First, expect taxes to be higher on income over $400,000. Second, expect payroll taxes to be expanded to include income over $400,000. Third, expect capital gains to be taxed at a higher rate if your income exceeds $400,000.
Should these changes be enacted, and we expect them to be in the first half of 2021, your challenge will likely be to reduce your taxable income on an annual basis. This can be through increasing expenditures on business assets and real estate, hiring, and possibly implementing new funding of charitable activities. Having a CPA who can help run projections for various strategies is going to be key.
TL;DR - Taxes are likely going up for business owners in 2021. Make a plan for how to move yourself and your business forward as tax efficiently as possible.
Estate Tax Lifetime Exemption Decrease
The current exemption sits at $11.58M in total assets that can transfer at your death without being subject to estate tax. As with the tax rates above, nothing is final until the ink is dry, but we believe that a return to the exemption amounts prior to 2017 is likely. Adjusted for inflation, this means that the exemption number is likely going to be close to $6M. So for businesses that you hope to pass down inside the family, making gifts of ownership to lock in the current exemption amount should be part of your discussions with your estate planning attorney and/or CPA.
TL;DR - Estate taxes will likely apply to lower amounts of wealth in the future so take a look at gifting and transfers today.
If you think of your financial life as a very long game with conditions that change over time, this upcoming year may bring a few more changes than normal. Play on!
Important note and disclosure: This article is intended to be informational in nature; it should not be used as the basis for investment decisions. You should seek the advice of an investment professional who understands your particular situation before making any decisions. Investments are subject to risks, including loss of principal. Past returns are not indicative of future results.