Do you have clients who are thinking of selling their businesses? If you have planned it correctly, most of the transaction proceeds should be long term capital gains. Given the current political climate and the change in the White House, capital gains taxes will come under attack. If you have business owner clients who are thinking of selling their businesses within the next five years, you may want to move up the exit timeframe.
The reduced 15 percent tax rate on capital gains, previously scheduled to expire in 2008, has been extended through 2010 as a result of the Tax Reconciliation Act signed into law by President Bush on May 17, 2006. In 2011 these reduced tax rates will revert to the rates in effect before 2003, which were generally 20 percent.
With the AMT currently targeted for elimination, the $800 billion will be made up by raising taxes elsewhere, and I believe this “owner of capital” tax is the most vulnerable for increase. I expect that the long term capital gain tax rate will be moved to an upper limit of 25 percent by mid-2009 for the high-end income bracket.
Translation? The business seller is going to take a big hit on his after-tax proceeds if his business sale is concluded after July 1, 2009. Let’s look at a quick example. A 63 year old man started his business 25 years ago and sells it for $5 million. All his equipment has depreciated so his basis is approximately $0. Under current tax laws he would have a $5 million capital gain from the sale of his business. His after-tax proceeds would total $4,250,000.
If he sells after July 1, 2009, and the tax laws change as I am predicting, the same sale would net him $3,750,000. He lost $500,000 because of this change. If you wait until the actual change is voted into law, there will be a rush to the exits causing an unusually high number of business to be for sale. That would further reduce proceeds for the seller because of supply and demand pressures.
The most important tax issue for the business seller, however, continues to be the corporate structure and whether the business sale is an asset sale or a stock sale. First, unless your client is planning on going public or has hundreds of stockholders, do not form a C Corp. If the business is already C Corp ask your attorney or tax advisor about converting to an S Corp. If you sell the company within a 10-year period of converting to an S Corp, the sale can be taxed as if it were still a C Corp.