The major federal tax and budgetary legislation approved by the Congress and the president last week contains several measures that will help independent insurance agencies.
Many of the tax changes that were enacted in 2017 were scheduled to expire at the end of this year. One major purpose of the new law was to prevent that. Expiration would have resulted in significant tax increases on many small businesses, insurance agencies included.
Probably most significant was the 20% deduction for pass-through entities. This tax provision was one that was due to expire; the new law made it permanent. According to the Independent Insurance Agents & Brokers of America (IIABA,) 86% of agencies are organized as pass-through entities, meaning that they pay income tax at the individual rate rather than the corporate rate. The provision enables taxpayers to deduct 20% of “qualified pass-through business income” from their taxable incomes.
Businesses will also be able to take advantage of more generous asset depreciation deductions. The prior law permitted businesses to write off depreciation equal to 100% of assets’ values in 2022, with that number gradually declining through 2024. The new law makes the 100% level permanent, subject to a higher maximum deduction of $2.5 million that is indexed for inflation. The deduction begins to phase out at levels of greater than $4 million. Agencies that upgrade their technology will be able to reduce their tax bills by writing off depreciation more quickly.
Owners of some agencies organized as “C” corporations have enhanced tax exclusions for gains made when they sell the stock. The law continues the current tiered system for excluding gains from the sale of “qualified small business stock” – 50% for stock held at least three years, 75% for stock held four years, and 100% for stock held for five years or more. It increased the maximum exclusion from $10 million to $15 million and indexed it for inflation. This means that an agency principal who has owned all the stock in his agency for at least five years may be able to exclude up to $15 million in capital gains when he sells the agency.
The law also locked-in the temporary changes to individual federal income tax rates set by the 2017 law. Five of the seven marginal tax rates were set to increase at the end of the year. The new law makes the lower rates, which range from 10% to 37% depending on tax bracket, permanent and indexed to the inflation rate. This greatly helps those insurance agencies that pay tax at the individual rate.
The capital gains tax rate was left unchanged at 20% on the sale of assets held for at least one year. However, the new law adjusted the applicable tax brackets. The law also raised the small business estate tax exemption to $15 million for individuals and $30 million for couples filing jointly. This exemption has been made permanent. A married couple can leave an agency to their heirs with the first $30 million in value tax-free.
Also made permanent were the higher standard deductions for individual taxpayers. The 2017 law temporarily doubled the standard deduction. This may make little difference to agencies that want to take advantage of the enhanced asset depreciation deductions. Deducting depreciation expense by definition requires the business to itemize its deductions rather than take the standard deduction.
One provision of interest to the insurance industry was left out of the final version of the law – a tax on proceeds from third-party litigation financing (TPLF.) TPLF has been blamed for increased litigation costs from meritless lawsuits and higher jury awards. These are factors in increasing liability insurance premiums and reducing coverage availability. The IIABA described this omission as disappointing.
The provisions in this major legislation will greatly help insurance agencies to limit their federal tax liabilities, freeing up capital for them to invest in staff and technologies to drive efficiency and improve client service. Agency professionals should consult with tax professionals to take full advantage of these new benefits in the tax code.
