How BPS companies can prepare for tax changes under Trump administration in 2025

ARTICLE | December 20, 2024

Authored by RSM US LLP

Executive summary: BPS companies’ approach to potential tax changes in 2025

BPS companies should consider the following to prepare for potential tax changes under the Trump administration and Republican Congress in 2025:

1. Entity structure: The choice between structuring as a pass-through entity and C corporation will be influenced by changes in tax rates and the potential expiration of the 20% qualified business income deduction.
2. Exit strategy: The approaching expiration of TCJA provisions may prompt BPS firm owners to consider exit strategies, such as employee stock ownership plans (ESOPs), which may offer tax benefits.
3. Capital expenditures: The phase out of bonus depreciation could impact investment in technology and infrastructure, with potential reinstatement supported by the Trump administration.
4. Debt: Limitations on deducting interest expenses affect highly leveraged BPS firms, with uncertain prospects for a more favorable limit.
5. Research and development: The current requirement to capitalize and amortize R&D expenses could be revisited, with bipartisan support for reinstating immediate expensing.

Business and professional services (BPS) firms have some clarity about the direction of tax policy in 2025, knowing the start of Donald Trump’s second term as president will coincide with a unified Republican Congress.

The Republican Congress will be able to pursue broad legislation that remakes the U.S. tax landscape before dozens of provisions in the Tax Cuts and Jobs Act (TCJA) expire at the end of 2025. With nonexpiring provisions and provisions outside of the TCJA also subject to change, new legislation could significantly alter businesses’ cash flows and tax obligations.

Ahead of any tax changes in 2025, BPS companies can equip themselves to make smart, timely decisions by understanding how different tax policy scenarios would affect their tax profile, cash flow projections, valuation and net income.

Below, we highlight for BPS firms several key business issues that tax legislation in 2025 could affect.

Entity structure

Entity type directly affects enterprise value because it determines how a business is taxed. BPS firms should be sure their priorities align with the cash flow and tax implications of being structured as a pass-through entity (S corporation or partnership) versus a C corporation.

The tax policy crossroads

As corporate, individual and U.S. international tax rates change, so does the tax-efficiency of different entity types. Congressional Republicans generally have been supportive of retaining the current tax rate structure. However, several House Republicans have acknowledged a potential need to increase the corporate rate to raise revenue to offset the cost of extending provisions in the TCJA.

In addition to potential rate changes, the following two provisions are subject to change in ways that could not only compel BPS businesses to reconsider their entity choice, but also challenge investors in BPS firms to reassess the profitability of those investments:

• Qualified business income deduction: For noncorporate taxpayers (i.e. pass-throughs), the TCJA provided a deduction of 20% of qualified business income earned in a trade or business. If this provision sunsets on Dec. 31, 2025, as scheduled, BPS firm partners could face higher effective tax rates and might need to consider restructuring to achieve more favorable after-tax cash flow. Notably, the nonpartisan Congressional Budget Office in May estimated it would cost the federal government $684 billion to extend this deduction. That estimate would likely invoke a broader discussion around the need for revenue raisers.
• Qualified small business stock gain (QSBS) exclusion: This provision, designed to incentivize investment in startups and small businesses, allows noncorporate taxpayers to potentially exclude from federal tax up to 100% of capital gains from the sale of qualified small business stock if certain requirements are met. The QSBS exclusion does not expire under TCJA, but with the scheduled sunset next year of both lower individual income rates and the qualified business income deduction, the exclusion could help a C corporation structure compare more favorably to a pass-through entity.

Deduction for qualified business income

Qualified small business stock gain exclusion

Corporate income tax rate

Individual income tax rates

Foreign-derived intangible income (FDII)

Global intangible low-taxed income (GILTI)

Base erosion and anti-abuse tax (BEAT)

BPS firms should consider:

• Whether potential rate and provision changes make a particular entity type more attractive. In conjunction with this, businesses should consider the impact of structural changes on the business’s ability to change or adopt new methods of accounting in the year of the rate change.
• Accounting method changes and/or elections to accelerate or decelerate taxable income, in order to maximize permanent savings through tax rate arbitrage.
• Tax leakage from a global perspective. When U.S. investors deploy capital into non-U.S. funds, the tax leakage should be examined to ensure U.S. investors have mitigated as much tax exposure as possible.

Exit strategy

With several tax rates and provisions subject to change in ways that could significantly alter the tax profiles of BPS firms, the approaching TCJA expiration date may encourage some owners to contemplate their exit strategies.

To that end, an employee stock ownership plan (ESOP) is an increasingly popular avenue for BPS firm owners to create their own liquidity event to exit. ESOPs provide a unique tax benefit: When someone sells their stock to an ESOP, they can potentially defer paying the federal capital gains tax, with certain limits, if they direct the proceeds toward qualified reinvestments. Aside from tax advantages, ESOPs are gaining momentum in the market for succession planning as an alternative to traditional exit plans.

The tax policy crossroads

For businesses, the key tax policy variables affecting exit strategy considerations overlap with those affecting entity choice.

The tax profiles of pass-through entities depend partly on whether the 20% deduction for qualified business income is extended. That deduction also affects how the after-tax outcomes of exiting a pass-through entity compare to exiting a C corporation, especially if the qualified small business stock gain exclusion remains in effect.

Deduction for qualified business income

Qualified small business stock gain exclusion

Corporate income tax rate

Individual income tax rates

BPS firms should consider:

• Modeling the five-to-10-year outcomes of various exit strategies, depending on entity type. Those analyses can help identify an entity type and transition plan that aligns after-tax outcomes with priorities for the business, as well as help to maximize the economic benefit to shareholders.
• Learning more about ESOPs as a potential exit strategy. Selling shareholders may find it to be an attractive ownership transition tactic that has minimal impact on the company’s day-to-day operations, may be more tax advantageous than other ownership transfers and preserves the legacy of the business.

Capital expenditures (Bonus depreciation)

When it comes to capital expenditures, accelerated deductions can widen avenues for BPS companies to invest in advanced technology and infrastructure, including new equipment, software and office improvements.

The tax policy crossroads

Companies’ ability to deduct the entire cost of qualified assets the year they are acquired and placed in service—a provision known as bonus depreciation—began to phase out in 2023, under the TCJA. Trump and congressional Republicans support restoring this notion of bonus depreciation as a tax incentive for capital expenditures that drive infrastructure and business growth.

However, the CBO estimated in May 2024 that reinstating full bonus depreciation retroactively to 2023 would cost the federal government $378 billion through 2034.

Bonus depreciation

BPS firms should consider:

• Performing a cost segregation study and repairs study concurrently with any planned improvement projects in order to properly classify shorter-lived property.
• If 100% bonus depreciation is extended, it may be prospective only, in which case the timing of any placed-in-service date could significantly affect cash flow in 2025. Properly identifying asset classes and deductible repair costs is the best way to ensure the fastest recovery of capital expenditures.
• Making various depreciation-related elections (e.g., an election not to claim bonus depreciation) that can be used to increase taxable income in one year without imposing similar treatment in a future year. If used correctly, these types of elections can provide a permanent benefit if tax rates change.

Debt

Many private-equity-owned BPS firms have substantial debt balances, especially shortly after the sale to private equity, but they also have the cash flow to afford the leverage. However, the unfavorable limit to deducting interest expense can significantly affect cash flows.

The tax policy crossroads

The business interest deduction limitation under section 163(j) became less favorable in 2022, as required by the TCJA. The current limitation does not expire.

There is some Republican support for a more favorable deduction limit, but it was not a top priority for either party in negotiations that produced the ill-fated Tax Relief for American Families and Workers Act early in 2024. It remains to be seen whether Republican support is strong enough to result in a change. The cost of more favorable tax treatment will factor heavily in what Congress does.

BPS firms should consider:

• Analyzing how more favorable expensing of business interest would affect borrowing or transactional strategies
• Opportunities to electively add interest expense to the cost of inventory or assets that have a shorter lifespan. By capitalizing interest to property with a short turn, the interest expense is no longer subject to the deduction limits and is instead recovered through cost of goods sold or depreciation.
• Capitalizing interest expense to accounts receivable. This approach typically reduces the interest limitation for BPS companies more than the inventory or fixed asset approach mentioned above.

Research and development

The U.S. tax system incentivizes innovation and promotes global competitiveness through credits and cost recovery mechanisms intended to reduce the financial burden companies take on when they invest in new products and technologies.

For BPS firms, greater or more immediate deductions could lead to higher after-tax cash flows.

The tax policy crossroads

The tax treatment of R&D expenses under section 174 became less favorable, as required by the TCJA. Beginning in 2022, companies are no longer able to fully deduct R&D expenses in the year they are incurred; instead, they have to capitalize and amortize them over five years (15 years for R&D conducted abroad.)

There is bipartisan support for reinstating immediate R&D expensing. But it’s uncertain how much it would cost the government to implement more favorable R&D expensing rules and how that cost would factor into a broader tax package.

Notably, in some prior attempts to restore full expensing for R&D expenditures, Congress has also reinstated a requirement for taxpayers to either take a reduced R&D credit or include the credit into income, reducing its value.

R&D expensing under section 174

BPS firms should consider:

• Their future R&D spending and whether it makes sense to conduct R&D in the U.S. or abroad. Costs for R&D conducted outside of the U.S. are currently subject to a 15-year recovery period instead of five, regardless of whether the taxpayer is located in the U.S.
• How their approach to R&D would change if Congress reinstates immediate expensing of R&D costs.
• The interplay between the R&D tax credit and tax treatment of R&D costs. While the former is often the more compelling option of the two, the restoration of immediate expensing would improve the comparison.
• The completeness and accuracy of their reporting for R&D tax credit claims and R&D expenses. The IRS is requiring additional detailed project reporting on future tax returns and is heavily scrutinizing R&D tax items. The IRS is also exploring incorporating artificial intelligence into their audit procedures around R&D credit claims.
• Whether their global structure for managing intellectual property is tax-efficient.

The tax policy road ahead

Expect the path to new tax legislation in 2025 to be unpredictable, difficult to follow at times and lined with conflicting claims by lawmakers, think tanks, news media and other analysts. However, BPS firms have a guide.

Those that work closely with their tax advisor to monitor proposals can model how tax changes would affect their cash flows and tax obligations. This can equip companies to stay confidently on course and make smart, timely decisions once policy outcomes become clear.

In recent years, many tax law changes have become effective on the date a bill was introduced rather than the date it was signed into law or later. Companies that are prepared for law changes and their effects will likely experience the greatest benefits.