Donald Trump promised companies a “massive” tax cut. Businesses aren’t likely to benefit equally, however.
Small and especially midsize companies stand to gain the most from a straight corporate tax cut, though only if they’re profitable, according to interviews with members of Bloomberg’s Breakaway network, which encompasses 78 high-growth businesses with annual revenue averaging about $450 million.
The Trump administration has proposed reducing the maximum tax rate from 35 percent to 15 percent. House Republicans favor a 20 percent rate; they also want to lower the top rate for so-called pass-through entities, a category that includes limited liability companies and S corporations, from 39.6 percent to 25 percent. More than 90 percent of U.S. businesses—28.3 million—are pass-throughs; most are small to midsize. Under Trump’s plan, the 15 percent rate would also apply to such enterprises. That could benefit his own businesses, which are structured as limited liability companies.
One important caveat: Only profitable enterprises will see any advantage from a cut to the corporate rate—and that’s more likely to be mature companies than startups. Among publicly traded corporations, 82 percent of mid-caps were profitable in 2016, vs. 68 percent of smaller companies, according to FTSE Russell, which compiles various stock indexes.
“I know that many companies like ours will not benefit from President Trump’s proposed tax breaks,” says Kara Goldin, founder and chief executive officer of Hint Inc., a San Francisco-based health-drink company founded in 2005. “We’ve been investing heavily to build our business and create jobs for the past decade,” she says. “Because of these heavy investments, we have past losses that we can use to offset taxes for quite a while.”
The House plan would eliminate the deduction for interest payments by businesses, a provision Trump has used, according to the limited public information about his tax returns. The proposal U.S. Secretary of the Treasury Steven Mnuchin unveiled on April 26 didn’t touch on the future of that deduction. “Many midsize and smaller companies don’t have access to the capital markets to the same extent large companies do,” says Kate Barton, vice chair of tax services at EY Americas. “They have to go out and get debt to grow.” Without the interest tax deduction, their financing costs will be higher.
Companies with international operations often park profits abroad to defer U.S. taxes. To induce them to bring that money home, Trump’s plan offers a “tax repatriation holiday,” which he originally proposed at a rock-bottom tax rate of 10 percent; the House GOP plan recommends rates as low as 3.5 percent. The final details still need to be ironed out.
“We’ve got offshore earnings for sales out of our Hong Kong operation,” says Walter Johnsen, CEO of Acme United Corp., a scissors manufacturer based in Fairfield, Conn. “If we were to bring those profits back into the U.S., they would be taxed at 35 percent instead of Hong Kong’s 16.5 percent.” Johnsen says he plans to pursue an acquisition outside the U.S. with the $12 million in cash he expects Acme to have by yearend from its international units, but he’d probably expand at home if the U.S. tax code became more forgiving.
Republican congressional leaders Paul Ryan, speaker of the House, and Texas Representative Kevin Brady, chairman of the House Ways and Means Committee, want a border-adjusted tax to pay for corporate tax breaks. This would disallow operating-cost deductions for profits made from imported goods while allowing a full deduction for all domestically produced goods. It would also favor small and midsize businesses, because they’re more domestically oriented, and benefit exporters while penalizing importers—in particular retailers such as Wal-Mart Stores Inc. that sell mostly foreign-made goods.
Although calls for a more simplified tax code have emerged from many quarters, AOL Inc. founder Steve Case says there’s a need for nuance. “When people think about tax policy as related to business, they think about it in too much of a one-size-fits-all way,” says Case, now CEO of venture capital firm Revolution LLC. “The reality is, there are three very different sectors. The big businesses are thinking about global taxes and profit repatriations. Small business as represented by the U.S. Chamber of Commerce is often thinking about simplifying regulation and minimizing taxes. But the real place to focus if you want job creation is on young, high-growth startups.”
According to the Ewing Marion Kauffman Foundation, companies less than five years old were responsible for almost all the net job growth in the U.S. from 1988 to 2012. Those less than a year old are most important, creating a total of 1.5 million jobs each year. However, startups are heavily concentrated in a few places. “Last year, 78 percent of venture capital went to just three states—California, New York, and Massachusetts,” Case says. To spread the wealth, he prescribes targeted tax breaks for startups outside those states.
Some provisions in the White House tax proposal may wind up hurting job-generating young companies. On the campaign trail, Trump called for doing away with tax breaks for carried interest. That’s the profit that accrues to the principals in private equity, venture capital, and hedge funds, which is currently taxed at only 20 percent. While private equity and hedge funds don’t do much to facilitate job growth, venture capital firms do. “Maybe there should be no tax on a small regional venture capital firm with $20 million in places like Lincoln, Nebraska, while there should be higher taxes on hedge funds, private equity firms, or large venture capital firms that only invest in Silicon Valley,” Case says.
The bottom line: Midsize businesses and pass-through entities will get the biggest bang from Trump’s tax plan.