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Financial Planning > Tax Planning > Tax Reform

Jamie Hopkins: How a Capital Gains Tax Hike Will Affect Advisors

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What You Need to Know

  • The proposed capital gains tax increase stands to have a larger impact on advisors than other proposed tax changes.
  • That is especially the case for those who are looking to sell their firm.
  • There are, however, options to avoid paying a huge tax bill, including selling the firm in installments over time.

The capital gains tax increase from 20% to 39.6%, proposed by President Joe Biden to fund his American Families Plan, would not only significantly affect individuals who make more than $1 million annually, but also financial advisors who are looking to sell their businesses, according to Jamie Hopkins, managing partner of wealth solutions at Carson Group and a finance professor at Creighton University.

Of the proposed tax increases, the capital gains tax hike has the largest potential impact to most advisors, he said Thursday in the webinar “A Changing Capital Gains Tax and What Else to Consider During a Sale.”

The conversations he has had with financial advisors in recent weeks certainly reflected that concern, he said, noting many of those talks were centered on the proposed capital gains tax increase and the impact it would have on a sale of their businesses.

After all, an advisor “might not have a million dollars of recurring income every year, but when you have these liquidation events, those could be the things where all of a sudden, people are pushed into this very high” tax bracket, he said.

On top of the capital gains tax increase, you also have to factor in the 3.8% net investment income tax that was passed as part of the Affordable Care Act, Hopkins noted. As a result, “all of a sudden, you can see that you could be losing a significant portion of the value you think you have in your business,” he said.

Research indicates that many people will just hold on to their business or any other huge assets and leave them for their estates banking on a step-up in basis, he said. Therefore, an “increase in capital gains without the removal of step-up in basis in essence doesn’t generate much revenue,” he said.

If a firm is valued at $6 million today, at the current 20% tax rate, the owner of that business would have to pay a $1.2 million capital gains tax bill. Under the proposed 39.6% rate, that number jumps to more than $2.3 million, Jason Carver, managing director of mergers and acquisitions at Carson Group, pointed out by email before the webinar.

During the webinar, Carver pointed out that if an advisor’s firm has $300 million in assets under management, annual revenue of $3 million, and $1 million in EBITDA, that business owner would pay an effective tax rate of 23.13% on a sale, including the net investment income tax rate, and have net proceeds of $5.7 million. Under the proposed capital gains tax increase, there would be $1.176 million lost, he said.

The business would have to see a 28% growth rate “to just get back to breakeven,” and that is difficult, Carver said: “To be honest, I don’t know how many businesses out there, especially at this size, are growing at 28% per year.”

It could take five to six years to make up that lost money, he said.

Advisors Have Options

But advisors looking to sell have options other than selling their firm entirely and paying the full tax burden in one year. Accepting a minority investment in one’s business instead of selling it is one option.

Carver has seen more minority deals being made, he said, adding that, for Carson, it’s “been our primary focus and has been for the last three years,” he said. “I think you’re going to see more and more of that, especially this year,” he predicted.

“If you’re worried about capital gains, but you’re not convinced you’re ready to sell” the business, a minority deal represents a good way to hedge your bets, he said. If you sell 20% of the business, “that’s a great way to hedge that risk,” Carver said.

And that “dovetails into my second point,” which is that installment sales are another option for advisors looking to sell their businesses. He forecast that “more and more” such sales, in which a business owner sells a business in pieces over time, will be seen, especially if the capital gains tax rises. It’s a “creative way to … stay below that $1 million threshold, and you’re selling in installments over a period of time, … You’re just mitigating that risk of getting this huge tax bill, because I’m over a million dollars all in the first year,” he explained.

The Clock Is Ticking

Noting that “we’re sitting here in almost July,” Carver said: “We are getting towards the back half of the year. And so if you’re at that point where you’re considering doing a transaction, you don’t want to wait till September. … If you’re talking to me [and] it’s September-October, it’s too late.”

Completing a transaction the right way typically involves a consultant, and that, plus the “investment banking process in and of itself … takes four to six months minimum,” he warned, adding: “I’ve been in processes that are more like six to 12 months.

“So if you’re really thinking, ‘hey, I want to engage an intermediary to sell my business,’ well, the clock’s ticking, because you need to get on that fast. But even if you don’t engage an intermediary, and you’ve had conversations with people, that still is going to take three to six months,” factoring in negotiations and a couple of months of due diligence, he said.

Therefore, “if you’re thinking, ‘hey, now’s the time, I want to do a deal before the end of the year,’ you’ve got to start that process if you really want to get something done by December 31,” he said. He then pointed to another advantage of minority investments: They take less time to complete.


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