Should You Sell Your Business This Year?

With a new President comes new tax laws. 

While nothing has been passed yet, President Biden has proposed the American Families Plan, which would substantially change tax rates for high-income individuals. 

One aspect of that reform includes increasing the long-term capital gains rates (for those with income over $1 million). 

Historically, long-term capital-gains (assets held for more than a year) have had preferential tax treatment. Depending on your income, LTCGs are taxed at either 0%, 15%, or 20%. For those lucky enough to have over $500k in income (roughly), Long-Term Capital Gains are taxed at 20%, which is much lower than the Ordinary Income Tax Rates for people at that income level, which could be around 35-37%. 

So What Is Biden Proposing?

The American Families Plan would eliminate the preferential LTCGs rate for those with income over $1 million. Meaning, LTCGs over $1 million would be taxed at their Ordinary Income Tax rate, which could be as high as 39.6% under the new proposal (since Biden is proposing increasing the highest rate from 37% to 39.6%).

Fortunately, this won't apply to many people (only about 0.3% of households have income over $1 million), HOWEVER, it could apply to business owners who are planning to sell their business soon and expect to incur a one-time capital gain on their business in excess of $1 million. 

For these business owners, they may not normally be in that income range, but due to the growth of their business over the course of their career, they may have substantial gains waiting to be realized upon sale.

This could drastically increase the amount of taxes paid on income from the sale of the business, which obviously decreases the amount that goes into the pocket of the business owner.

The Case of Jack & Jill

Jack and Jill are married business owners who plan to sell their restaurant chain soon, and they expect a gain of $3.5 million.

Under the current tax law, 100% of that would be taxed at the preferential long-term capital gains rate of 20%; this would equate to about $700k in taxes.

Under the American Families Plan, $2.5 million of that would be taxed at the highest ordinary income tax rate of 39.6% (the first $1 million would be taxed at 20%); this would equate to about $1.2 million in taxes!

That's a difference of almost $500k in taxes! 

• Jack and Jill are married business owners who plan to sell their restaurant chain soon, and they expect a gain of $3.5 million.

• Under the current tax law, 100% of that would be taxed at the preferential long-term capital gains rate of 20%; this would equate to about $700k in taxes.

• Under the American Families Plan, $2.5 million of that would be taxed at the highest ordinary income tax rate of 39.6% (the first $1 million would be taxed at 20%); this would equate to about $1.2 million in taxes!

• That's a difference of almost $500k in taxes! 

While Biden's budget implies that these new rates would be retroactively enacted to April 2021, in reality, it's unlikely that these rates would become effective prior to January 2022. 

But the time for planning begins NOW!

Due to the major tax implications this new proposal presents for high-earners, business owners planning to sell their business in the near future may want to consider accelerating the sale of their business to 2021. 

Assuming that Biden's new tax plan becomes effective in 2022, waiting just another 6 months to sell your business could mean the difference of hundreds-of-thousands of dollars (for those expecting to incur income of over $1 million). 

As always, the right course of action depends on your unique situation. The goal is obviously to maximize after-tax proceeds.

For instance, if your business is on track to substantially increase in value over the next year, to the point where it would make up for any additional taxes by waiting, then it may make sense to wait.

Alternatively, depending on how much you plan to sell for, structuring an installment-sale may help spread out the income to a point where you could stay under the $1 million threshold. 

Either way, if you are even thinking about selling your business in the near future, take into consideration upcoming tax changes. And if you need someone to brainstorm with, don't hesitate to reach out.