How financial services companies can prepare for tax changes under Trump in 2025

ARTICLE | November 15, 2024

Authored by RSM US LLP

Financial services companies have considerable clarity about the direction of tax policy in 2025 now that Donald Trump has been elected president and Republicans have flipped control of the Senate while retaining control of the House of Representatives.

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

Before any tax changes take effect, investment funds, trading firms, operating companies and portfolio 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 financial services companies several key business issues that tax changes could affect.

Returns on investments

Over the past year, various factors have challenged financial services companies' ability to generate desired returns, including higher interest rates, elevated costs of capital, increased market volatility, high regulatory compliance costs, and the need for capital expenditures to implement productivity-enhancing technologies.

The tax policy crossroads

Tax policy discussions in recent years have commonly included the question of whether to tax carried interest and long-term capital gains as ordinary income or at more favorable rates. A unified Republican government is likely to favor maintaining preferential tax treatment for these types of income.

Carried interest

Capital gains tax rate

Entity structure

Entity choice directly affects enterprise value because it determines how a business is taxed. Financial service organizations 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.

Budgetary considerations will also help shape the discussion about extending individual income tax provisions, which would cost an estimated $3.2 trillion, according to the nonpartisan Congressional Budget Office. Extending the U.S. international tax rules would cost an estimated $141 billion.

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)

Financial services companies should consider:

• Whether potential rate 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.

State and local tax planning for investment fund executives

In addition to tax rates, various deduction limitations are subject to change. The TCJA introduced a cap of $10,000 on the deduction for state and local taxes (SALT), significantly impacting taxpayers in high-tax states. This cap, along with other changes to itemized deductions, is set to expire after 2025. General partners should plan accordingly with their tax advisors.

The tax policy crossroads

The TCJA limited the itemized deduction for state and local taxes to $10,000. Before that, there was no limit. Since the TCJA was enacted, the SALT cap has remained unchanged despite scrutiny by both major political parties.

The Republican-controlled government might aim to either extend the SALT cap and other itemized deduction limitations, or modify them in some way going forward. For example, the SALT cap could be increased but not eliminated. The CBO estimated that allowing the sunset of TCJA changes to itemized deductions, including the SALT cap, would cost $1.2 trillion.

State and local taxes (SALT)

Fund partners should:

• Factor in SALT deductions when evaluating their investment structure and future acquisition plans.
• Model their tax projections for various scenarios, including scheduled expiration of the SALT cap on Dec. 31, 2025; an increase in the SALT cap, or a permanent $10,000 SALT cap.
• Evaluate alternate strategies, such as making a pass-through entity election.
  

Debt financing

As interest rate cuts release pent-up demand for deals, institutional lenders can expect an uptick in loan applications from businesses and individuals. Meanwhile, specialty lenders can appeal to borrowers with unique needs by offering more flexible terms and innovative products. This dynamic can lead to a more competitive lending environment, fostering growth and potentially driving economic activity as more deals are financed and executed.

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.

Financial services firms should consider:

• How more favorable expensing of business interest would affect their lending or transactional strategies

Research and development

For financial institutions, broker-dealers, trading firms, insurance companies and other financial services operating companies, greater tax incentives for R&D could free up cash to fund new software, applications, and innovation featuring automation and artificial intelligence. Such initiatives can enhance claims processing, trading strategies and other outputs by creating efficiencies and improving accuracy. They also can elevate customer experience and ultimately widen companies’ operating margins.

The tax policy crossroads

The tax treatment of R&D expenses under section 174 became less favorable, as a result of 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.

U.S. multinationals should also monitor the foreign-derived intangible income (FDII) provision. It was enacted as part of the TCJA and designed to incentivize businesses to conduct R&D in the U.S. by offering lower tax rates on income from U.S.-held intellectual property used abroad.

R&D expensing under section 174

Foreign-derived intangible income (FDII)

Financial services companies should consider:

• How their approach to R&D would change if Congress reinstated immediate expensing of R&D costs, including whether it makes financial sense to outsource R&D.
• 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.
• 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.

Portfolio companies

Our series of industry tax policy outlooks explain how portfolio companies in the following industries could be affected by tax changes in 2025:

• Consumer products
• Health care
• Life sciences
• Manufacturing
• Real estate and construction
• Technology, media and telecommunications
  

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, financial services organizations have a guide.

Those that work closely with their tax advisor to monitor proposals can model how tax changes could affect their cash flows and tax obligations. Modern tax technology that can clone data supports this type of scenario planning. In turn, this can equip organizations 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. Businesses that are prepared for law changes and their effects will likely experience the greatest benefits.