As the April 15 tax deadline approaches, independent agency owners should meet with their tax expert to review their current tax structure and better understand the tax implications of a potential sale now or sometime in the future.

Ask your tax expert to lay out various scenarios for you to help you determine if you are structured to minimize your yearly tax burden and the tax liability you will face when you eventually sell your agency.

Current Tax Law and How It Could Change

The Tax Cuts and Jobs Act went into effect in 2018 and, depending on how their business is organized, had specific implications for independent insurance agencies. Agencies that are organized as C-corps received a substantial cut to their corporate tax rate, which was lowered from 35% to 21%. These tax cuts are permanent.

Agencies organized as pass-through entities—S-corps, partnerships, limited liability corporations (LLCs) or sole proprietorships—also received favorable treatment under the new tax code. The law provides a 20% deduction of their qualified business income on their taxes, regardless of their income level. However, this law will expire in 2025 unless Congress acts.

With the approaching presidential election, as well as U.S. House and Senate seats up for grabs, there could be changes to the tax code in the near future, depending on who controls the White House and Congress. In his FY2024 budget, President Joe Biden indicated that he would like to double the capital gains rate from 20% to 39.6% for those with more than $1 million in income. 

By working with your tax pro, you will better understand how any potential changes could impact your estate.

Tax Implications of Selling Your Agency

Your corporate structure is a key determinant that will drive a future sale toward a stock or asset purchase.

In a deal, acquirers prefer to purchase the assets of an agency, not the stock. This is because there are tax benefits tied to asset purchases in addition to reduced liability exposure to the acquirer. Furthermore, an agency structured as an S-corp or LLC will avoid double taxation when the assets are sold, compared to the sale of assets from a C-corp.

During an asset sale, the buyer acquires all the intangible assets and most of the tangible assets from the agency but avoids inheriting the liabilities of the agency. Buyers, in general, prefer asset deals, whereas sellers prefer stock deals.

During a stock sale, the seller receives capital gains treatment on the proceeds. The amount of time that the stock was held before being sold determines its capital gains for tax purposes. Additionally, the seller leaves all the agency's liabilities, known and unknown, and contractual relationships with the entity, which is a disadvantage to the buyer.

Depending whether if it is a stock or asset sale, there are additional tax implications. In an asset sale, the tax advantages of capital gains income are not realized in a C-corp. Proceeds from the sale paid to shareholders are not tax deductible to the corporation but to the stockholders, meaning there is double taxation.

For an S-corp, there is no double taxation, as the proceeds from an asset sale pass through the agency to the individual owners, where tax is paid at their personal rate.

S-Corp vs. C-Corp

IA Valuations and the Ohio Insurance Agents Association (OIA) have completed hundreds of valuations over the past several years. It found that 32% were still structured as C-corps. Additionally, the average owner age of those structured as C-corporations was 58.6. And over 23% of the owners of C-corporations were past the age of 65.

When compared to the 2022 Reagan Best Practices study of similarly sized agencies, there is a profound difference when comparing the S-corps with the C-corps. 

Even if an agency structured as a C-corp isn't considering a sale right now, it could be beneficial to convert to a different structure sooner rather than later. There is a waiting period of five years to realize the tax benefits of a sale. 

IA Valuations recommends that agencies check with their accountants, attorneys and consultants to determine how they will be affected by the tax code based on their individual circumstances. The right professionals can help you understand the best options for your agency, both now and in the future.

Craig Niess is director of business planning and valuation at IA Valuations.

The information provided in these documents is general in nature and shall not be construed as personal legal, tax or financial advice for your situation. Please contact@iavaluations.com to discuss your personal situation. 

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