Selling a Business May Be Getting A Lot More Expensive
All indications are that changes to the tax code are coming. These are needed to fund the sharp uptick in government spending and are generally favored by Democrats, who now 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.
These changes to the tax code could be implemented retroactively, meaning that they would apply to the 2021 tax year, but the general consensus is that this is unlikely. However, if inquiries to financial advisors are any indication, there is 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.