Selling a Business May Be Getting A Lot More Expensive — or will it?
UPDATE (December 28, 2021): Contrary to earlier indications, attempts to nearly double the capital gains tax for high income earners is on hold for the time being.
As of summer 2021, all indications were that changes to the tax code are coming. These were considered necessary to fund the sharp uptick in government spending and are generally favored by Democrats, who control the White House as well as both houses of Congress, albeit tenuously in the case of the Senate.
According to an overview of the proposed changes by the American Enterprise Institute, a Washington think tank, President Biden's plan would tax capital gains and dividends as ordinary income for taxpayers who report $1 million or more. This means that capital gains for high income earners will bump up to 39.6%, the highest tax bracket under the proposal. Currently, capital gains are taxed at up to 20%, so this increase would roughly double the current rate.
So let's say you're selling your business for $10 million and are expecting $9 million at close with the remainder going into a seller note. Assuming $8 million in capital gains from the sale and no state capital gains tax, you'd take home $6.4 million under the current tax code and around $4.8 million under the proposed plan.
Here's a cleaner example assuming a $10 million valuation, all of which is capital gains and all of which would be paid at closing. Assuming the tax proposal is implemented, you would need to increase your company's valuation to over $13 million to receive as much from the transaction as you would under the current tax regime.
There was even some talk of these changes to the tax code being implemented retroactively, meaning that they would apply to the 2021 tax year, though the general consensus was that this was unlikely. However, inquiries to financial advisors had indicated that there was a good chance that there will be changes to the tax code that will take place in 2022 — even if these changes are moderated as the proposals work their way through the legislative process.
Worth thinking about if you are considering the sale of your business.