Todays’ newsletter is written to help you, the business owner, consider the fact that without proper planning, the government’s ‘partnership’ in your business exit may be increasing yet again. With another potential increase in the Federal capital gains tax rate, you may face a situation where your ‘exit proceeds’ are shared at a much higher level with the government. There are a number of things that an owner can consider when made aware of this fact. This newsletter is written to present this issue as well as provide a few ideas on how to potentially manage the situation
Three (3) Parties to Every Transaction
It is helpful to think about the government as a part of your future exit transaction. In fact, it has been said that each exit transaction has not only the buyer and seller, but a 3rd party, the government. And, as a party to your transaction, the government is quite clear on its expectation of payment. It is your job to be just as clear and to make plans to see if this ‘3rd party’s role’ in your deal may be reduced in order to leave you with more exit proceeds from your transaction.
Uncle Sam is a Partner in Your Exit
Privately-held business owners know all too well that the Federal government is a partner in the success of your privately-held business – the taxes that you pay each year are evidence of this fact. But did you know that the government is also a partner in your exit transaction? And, without proper planning, the government’s take on your business transaction may be significantly larger than you might expect.
Four (4) Primary Taxes to Consider
For most exiting owners, there are four (4) primary taxes that you should be focused on for your overall business exit and wealth protection strategies. These taxes are:
1. Capital Gains Taxes
2. Ordinary Income Taxes
3. Corporate Taxes
4. Estate Taxes (both Federal and State levels)
These various taxes are what makes the government a partner in your decisions. When dollars flow into and out of your business different tax rates apply. The capital gains tax rate is generally the most favorable but may not be available for your transaction.
Federal Capital Gains Tax Proposed to Increase to 28%
In the White House’s proposed 2016 budget that was sent to Congress, there is a recommendation to increase the current Federal Capital Gains tax rate from its current level of 23.8% (including the 3.8% affordable care tax supplement) to a total of 28%. Moreover, there is quite a bit of relevant language that helps explain the rationale behind the proposed increase, including the ‘inequities’ of the wealthy who get the preferential tax benefit of a longer-term holding period for their equity holdings. The proposed rate change and the accompanying language are telling of the state of view of wealthy owners and the allocation of taxes.
What Tax Rate will You Pay
You should know that when you exit your business, your future owner can purchase either your ‘assets’ or the stock in your business. In either case, the new owner will own and control your company. However, an ‘asset’ sale can have a very different tax outcome to you than a stock sale. Therefore, understanding what type of exit transaction you will experience and what the tax impact will be becomes an important part of your overall exit planning.
An Example of Managing your Exit to ‘Keep’ More of What You ‘Get’
Let’s take an example of an owner who anticipates that a future buyer will offer to purchase the assets of their business. In fact, this owner may know that ‘asset sales’ are how many/most other businesses have transferred in that industry. This exiting owner forecasts that the sale of the company’s assets will subject his proceeds to ordinary income tax rates, which are likely significantly higher than current capital gains tax rates.
However, if the same owner can convince his buyer to purchase the stock of the business, then the capital gains tax will likely apply. Further, if a transaction can be completed in 2015, it is most likely the case that the current capital gains tax rate will apply to the transaction. So, on the sale of a $10 million business, the difference between completing a transaction in 2015 versus a potential increased rate applying to a 2016 transaction can translate into $380,000 in tax savings.
Keeping an eye on current and future changes to tax rates will help you to plan more accurately for your exit. After a lifetime of work, most owners agree that they would like to keep more of what they get from their exit. Accordingly, giving consideration to some of your anticipated taxes with your exit can assist you in navigating this complex area with greater precision and control over the outcome.
Below is a link to a 10 minute, 20 question online assessment that can assist you in determining your financial and mental readiness for your exit. There is no fee to take the assessment and your answers are sent immediately to your e-mail and kept completely confidential.
As a business owner who may be thinking through the eventual exit from their business, this complimentary online assessment may be the ideal starting point. And, after receiving your Business Exit Readiness Index™ Owner’s report, you may want to take a follow up meeting to discuss your answers further and gain more clarity on how you will have a successful exit in the future.