2024 tax outlook for franchisees: Consider these changes ahead.
The tax outlook for 2024 and beyond is about as clear as, well, mud. With the sunsetting of benefits from the 2018 Tax Cuts and Jobs Act (TCJA) and the uncertainties about what the 2024 elections will bring, planning a tax strategy is a daunting task for franchise operators.
As a former CPA, I say there’s probably never been a better time to work with a tax advisor, especially one who is knowledgeable about franchises, to help you be prepared for whatever appears on the tax horizon in the next few years.
Potential for Higher Tax Bills
Most of the corporate and individual tax benefits of the TCJA will expire in 2025, which means many businesses and individuals are likely to have higher tax bills in 2026 and beyond. When timing major purchases or investments, operators need to consider their tax implications.
On the one hand, it could make sense to purchase a large piece of equipment in 2024, while the TCJA provisions still allow an 80% bonus depreciation deduction (which will go away in 2027). On the other, pushing some purchases and donations to 2026 and beyond might be a smart move if they offer the opportunity to claim deductions to offset (likely) higher taxes in the future.
Added to these questions are the uncertainties around the 2024 elections. Each party has its own agenda, and it’s unclear which, if any, of the TCJA provisions will be reinstated or allowed to sunset. There may even be new taxes or benefits that aren’t being talked about yet.
Impacts on Business Financing
A large increase in taxes can have a major impact on a company’s ability to obtain business financing. It’s all about the current ratio. Most lenders expect a borrower to have a current ratio of 1.5 or more. The current ratio is calculated by dividing the company’s current assets (cash plus those holdings that can be converted to cash quickly) by its current liabilities. Put simply, the lender wants to see that the borrower has at least 1.5 times the amount of cash or near-cash to pay its upcoming bills.
A significant increase in a company’s tax liability without a matching increase in current assets will lower the current ratio, making lenders more skeptical of its creditworthiness. A franchise owner considering an expansion loan or financing to purchase a new store needs to factor the possibility of future tax increases into their cash flow picture and their borrowing plans.
Another wrinkle in the business financing fabric is the future of interest expense deductions. The TCJA imposed lower limits on how much interest could be deducted, effectively increasing the cost of borrowing. Being able to deduct the interest on a business loan reduces the actual interest rate/cost of borrowing because there is a tax benefit. Without that deduction, the cost of borrowing is higher than the stated interest rate. Efforts are being made to bring the business interest expense deduction limits back to, or near, the pre-TCJA level. Timing a business loan to take best advantage of the business interest expense deduction involves trying to read the tea leaves about where the deduction levels will eventually settle.
Effects on Business Valuation
Higher tax liabilities without an offsetting increase in revenue may lead to tighter cash flows. In the past, buyers relied on EBITDA (earnings before interest, tax, depreciation and amortization) to establish the valuation of a business. In an environment where taxes are likely to make an oversized impact on cash flow, however, buyers now may want to take potential tax burden into consideration.
Previous cash flow multiples that would have applied to a franchise purchase may not apply in these new circumstances. Put another way, past cash flow experience may not be a good indicator of future performance, and buyers may lower their offers to reflect that uncertainty.
Value of Planning Ahead
With all these tax changes in the air, planning is vital. For business owners considering debt financing for buying, selling, expansion or succession, it’s wise to project cash flows out 3 to 5 years under various tax scenarios. Will cash flows be adequate (with the potential taxes that will need to be paid) to pay for the acquisition and service the debt? Working with a tax specialist familiar with the franchise industry can help make sense of this ever-changing landscape.
— Rick Dennen is the CEO of Indianapolis-based First Franchise Capital, a First Financial Bank company, with customized loan products and services for quick-serve restaurants nationwide.