By Chris Taylor, The Urie-Taylor Group, UBS Financial Services
About a year ago, we were breaking the record for the longest-lasting economic expansion in U.S. history, with seemingly no end in sight. But all of this changed, in mere weeks, as the shutdown of the global economy turned record-low unemployment into record-high unemployment and threatened the viability of previously flourishing businesses.
As we hope to begin the re-opening process, it is becoming clear that the disruption will leave a lasting impression and that business owners, and businesses alike, will need to make changes to their pre-crisis plans if they are going to survive one of the most challenging environments in history and thrive in the new post-COVID reality.
Adjusting the plan
When assessing which resources need to be redirected to adapt to the new environment, we recommend using the Liquidity. Longevity. Legacy. (3L) framework, which is designed to help investors earmark their resources to meet specific goals and invest them appropriately.5 Today, many business owners may find that they can no longer meet goals within the original time frame and that some of their resources will need to be redirected to get the business back on track. For example, many business owners that had been nearing a sale may need to postpone it and many business models may need another period of investment to adjust it to the new market realities. By using the 3L framework, business owners can work with their partners, their families and their financial advisors to make sure that their goals are up to date and that they have the right strategy to still meet them. For example, the Liquidity strategy is designed to separate out the resources that you need to meet your next three to five years of cash flow needs, and isolate them from market exposure, helping you stay focused on the long term. And the Longevity strategy helps you identify how much capital you will need to retire on time, and on budget, and how those funds should be invested. This leaves the Legacy strategy assets, which can be invested for growth to meet the needs that go beyond your own such as charity or future generations. For more information, we’ve published Uncommon success: Wealth strategy for entrepreneurs and business owners, where we discuss the process of building and adjusting your exit strategy before, during and after the sale.
A new reality
Business owners have already had to make drastic changes to their operations and they will need to continue to adapt to a new reality in the still-uncertain post-COVID environment. The good news for entrepreneurs is that these moments of challenge often bring opportunity for the well-prepared. In this article, we will walk through four major post-COVID trends and identify strategies that business owners can implement to take advantage of this window of opportunity. The expected time frame for these changes is long term.
More debt = higher taxes
Governments around the globe have implemented massive spending packages to “bridge the gap” during the economic shutdown. While some spending cuts are possible, there is little doubt that higher taxes are also on the menu. In the U.S., President-elect Joe Biden has proposed a more progressive personal income tax system, increasing the top income tax rate from 37% back to the pre-2017 level of 39.6% (43.4% including the 3.8% Net Investment Income Tax). For taxpayers with income above USD 1 million, capital gains and dividends would be also taxed at this higher rate. Among other proposed measures, Biden’s tax plan would add a 12.4% payroll tax on income above USD 400,000, cap the tax benefit of itemized deductions at 28% and tax unrealized capital gains at death. According to an analysis by the University of Pennsylvania, taxpayers in the top 0.1% of the income distribution would bear about 54% of the impact of these changes—with an average tax increase of USD 1.3 million per taxpayer in that bracket—and 80% of the impact would fall on the top 1% of the income distribution.
Corporate taxes are also likely to go higher in some jurisdictions. Biden has proposed raising the corporate tax rate from 21% to 28% in addition to a 15% “minimum book tax” on firms with $100 million or more in net income. In addition, we are likely to see more momentum behind a global proposal that would seek to tax businesses based on where revenues are generated—a policy that would have a particularly large impact on the U.S. tech giants but could also affect smaller U.S. firms that have tapped into global markets.
These proposed changes are not a foregone conclusion, and some provisions could be difficult to pass even under a Biden presidency unless Democrats are able to secure a majority in the House and in the Senate.
Last, but not least, it’s important to note that some of the 2017 personal income tax changes in the Tax Cuts and Jobs Act are due to “sunset” at the end of 2025. One provision is particularly important for business owners: the estate tax exemption—which was raised to USD 22.4 million for couples, indexed to inflation—is poised to be halved back to its original level (USD 11.2 million, indexed to inflation). Anything above this level will be federally taxed at a rate as high as 40% (in addition to state-level taxes that may apply at different wealth levels).
It’s possible that Congress could extend the current exemption level but given the state of the U.S. deficit—and the politics of U.S. wealth and income inequality—it seems more likely that the exemption could be lowered further or sooner. It often feels too soon to have an estate planning conversation but taxes aren’t the only reason to begin the process.
With revenues depressed in 2020, this may be an opportunity to gift shares of company stock at depressed valuations. There are also important family considerations. As we discuss in our report Legacy Strategy: How to leave a meaningful inheritance, the biggest impact on our families, and our communities, often comes through intentional lifetime gifting—where we can share in the benefit that comes from the monetization of our life’s work—rather than through an end-of-life bequest. Be sure to discuss these considerations with your tax professional, and your financial advisor, to determine if there are any strategies you can use to reduce your tax burden.
Lower interest rates
In addition to higher taxes, we also expect governments to rely on “financial repression” to manage their higher debt levels. By keeping interest rates low for a long time, central banks will implement a type of tax on conservative savers, and investors, who become less able to safely earn an above-inflation investment return. Financial repression helps to support the value of riskier investments such as corporate bonds and equities (some of which are being directly purchased by central banks) and allows banks to give lower-cost loans to businesses and individuals. In a low interest rate environment, borrowing strategies become relatively more attractive as a complement to traditional cash management strategies. In addition, low interest rates can reduce the cost of intra-family loans and increase the value of some estate-planning strategies such as Grantor-Retained Annuity Trusts (GRATs) – as discussed further in our report Advanced Planning Insights: Planning in a low interest rate environment.
Higher inflation, more localization
Another consequence of financial repression is that central banks are likely to tolerate a modestly higher rate of inflation, allowing the economy to run a little “hot” before they raise interest rates. Inflation rates have been low and falling for decades, so many of today’s businesses have not had any experience with rising inflation. Business owners should proactively consider ways to more effectively pass rising costs on to customers and investigate strategies for avoiding cost inflation on their inputs. As a part of their strategy for controlling cost inflation, we expect many companies to redouble their efforts to diversify their supply chain globally, including some localization of certain manufacturing processes. While these steps may often require an up-front investment, they can be seen as vital to protecting against the risk of higher tariffs and mitigating the risk of supply chain disruptions caused by protectionism, pandemics or other factors.
More digital
Another consequence of the COVID-19 crisis is the rise of remote work. Working from home has been a necessity due to the nature of the pandemic, but it has proven its value for many businesses that had been afraid to take a risk. In the post-COVID world, many companies will likely offer remote work as a benefit to attract, and retain, talent. Not all businesses will be able to do so, but it’s worth considering the potential value that remote work can add. In addition to helping a business maintain resilience during natural disasters, a more digital workplace can also lead to a more diverse, and dynamic, workforce since it effectively broadens the variety of applicants. When employees are able to move out of cities and into lower cost-of-living areas, their paychecks can go further. It’s a potential win-win: employees can spend time with their families instead of commuting and the business can invest in growth rather than real estate.
Conclusion
Business owners will face many new challenges in the more indebted, less global and more digital post-COVID world. But each potential disruption is also a business opportunity and even the prospect of a financial “triple threat”—higher taxes, lower interest rates, for longer, and modestly higher inflation—presents a window of opportunity.
Chris Taylor began his career at Merrill Lynch in 1992, working under industry veteran Richard Urie. Soon after, he partnered with Richard’s son Dane in 1993 to establish The Urie-Taylor Group. He earned his B.S. in finance and an M.B.A., from Florida State University. He has completed UBS Wealth Management Education and is certified in all UBS Portfolio Management Programs. Taylor holds his Series 7, 63 and 65 securities licenses as well as the State of Florida life insurance, health insurance and variable annuity licenses. Lastly, Chris holds an industry designation as a Certified Financial Planner. This is a formal recognition of expertise in personal financial planning, retirement planning and estate planning strategies.
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