By Joe Ciccarello, CPA, MST
February 4, 2021
If you have given any thought to selling your business and retiring, now might be a good time. And I mean right now.
The shift in power in Washington is likely to result in significant changes to federal tax laws, including capital gains taxes. Corporate tax rates are expected to return to the higher levels in place prior to the 2016 Presidential election, and deductions put in place for pass-through entities (including S Corps, LLCs, partnerships and sole proprietors) will probably be eliminated. That could feel very much like a tax increase on businesses of 20% or more.
Perhaps of more significance, President Biden has said he wants to eliminate the favorable tax rates on long term capital gains for anyone making over $1 million. This proposed change in the long-term capital gains tax rate is likely to impact business owners who sell their company. Current long-term capital gains are taxed at rates ranging from 0% to 20%, depending on your income. But the proposed changes would see long-term capital gains taxed as high as ordinary income, almost doubling the Federal taxes due for most transactions.
At this time there is talk of making these proposed tax changes retroactive to the start of 2021. However, it is more likely that any changes will go into effect at the start of 2022. Which gives you a window during which you can sell your business while the current, more favorable tax laws are in place. What difference will it make?
In a very simple example, if you sell your company for $750,000 today, the long-term capital gains tax rate would be 20%. That means you will owe the federal government $150,000. If you wait until the capital gains tax rates are changed to match the tax rates for ordinary income, the tax bill (assuming a 35% tax rate) could jump to $262,500. Are you prepared to hand over an extra $112,500 to Uncle Sam? (Please note that every transaction has different dynamics – your results may vary.)
Hopefully, you have an exit strategy in place that will allow you the flexibility to act quickly on a decision to sell. But even if you have only been “kicking the idea around” about selling your business, aligning with an experienced advisor can help you prepare and market your company while the opportunity to maximize your net proceeds is ripe.
Remember, the money you receive when selling your business will need to be enough to see you through your retirement years. While other factors may influence your decision to exit your business, it is imprudent to ignore the significant impact these proposed tax changes will have on the transaction, and the lasting effects the difference will make on your personal long-term financial health. You not only want to get the most money for your company, but need to plan how to make it last.
Joe Ciccarello, CPA, MST heads the business succession planning practice group at Gray, Gray & Gray, LLP, a business consulting and accounting firm. He can be reached at (781) 407-0300 or firstname.lastname@example.org