A Potential Rise in the Capital Gains Tax Rate Plan Your Business Exit Accordingly
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. President Biden campaigned on essentially abolishing the long-term capital gains tax rate by increasing it to the same top rate he’s proposing for ordinary income. This could mean an increase of 66% or more in Uncle Sam’s share of your ‘exit proceeds’. There are a number of things that an owner should consider when made aware of this fact.
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.
Or as Judge Learned Hand said in two (2) opinions: “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”
Gregory v. Helvering, 69 F.2d 809, 810 (2d Cir. 1934)
And “Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.
Commissioner v. Newman, 159 F.2d 848, 851 (2d Cir. 1947) – dissenting opinion
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 include :
- Capital Gains Taxes
- Ordinary Income Taxes
- Corporate Taxes
- 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 (and eventually your estate) different taxes and tax rates apply. The capital gains tax rate is generally the most favorable but may not be available for your transaction.
Increased Deficit/Debt Means Biden is Serious about Tax Increases
The 2020 pandemic has brought several large stimulus packages. According to Forbes, the deficit increased by $3.1 trillion in October of 2020 alone. Covid-19 relief accounted for $2.6 trillion of that and a new package is in the works for $1.9 trillion in more spending. The question about tax increases going forward isn’t IF?, but WHEN? and HOW MUCH?
President Biden will likely push for tax increases in late March or April, according to KPMG, as they will likely be part of a “recovery package”. Biden campaigned on raising the long-term capital gains rate to 39.6%. This is a 15.8 point increase and a whopping 66% increase in the long-term tax rate!
Retroactive Tax Law Changes are NOT Unprecedented
The 1993 Omnibus Budget Reconciliation Act is likely the most notable, but not the only time that Congress has made tax law changes retroactive to the beginning of the year in which they were enacted. The economy remains fragile due to the ongoing pandemic, so passing tax changes retroactively to January 1, 2021 is perhaps unlikely. That being said, the Democrats are keenly aware their majorities are narrow and could be gone with the 2022 mid-term elections, which further increases the likelihood that the Biden Administration will push for tax changes later this year or next.
Finally, Democrats have expressed the desire to utilize the reconciliation process to get laws passed by relying on their simple majority in both houses. This would short-circuit the 60 vote filibuster breaking requirement in the Senate.
Exits Take Time – Plan Accordingly
You should know that an exit planning process can take years to develop and execute and a business sale transaction can take up to a full 12 months from start to finish. Additionally, attempts to compress the timeframe can often result in loss of transactional leverage as an owner. Therefore, depending on how quickly Biden’s tax plan moves through Congress, by the time you complete the sale of your business, the sale proceeds could be impacted significantly if you don’t begin initial steps soon.
Tax law changes appear imminent and they are likely to bring large increases to the long-term capital gains rate as early as January 1, 2022. If you are like most business owners and the majority of your wealth is locked inside of your privately held business the threat of the government taking a larger share of your proceeds should make you reconsider your timetable. An exit in 2021 could look a lot different than an exit in 2022.
We hope that this newsletter achieved the stated objective of helping you, the business owner, think about keeping more of what you get with your exit and acting in a timely manner in this regard. Consult with your Exit Consultant on these issues to help assure that a planning opportunity is not lost due to delays and the passage of time. Remember the words of Judge Learned Hand “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury.”
Jacobi Wealth Advisors
1055 Westlakes Drive, Ste 135
Berwyn, PA 19312
PH: 610-722-5948 | F: 610-722-5894
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific
tax issues with a qualified tax advisor. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. Jacobi Capital Management, LLC, a Registered Investment Adviser Securities are offered through LPL Financial, Member FINRA/SIPC. Investment Advisory Services are offered through Jacobi Capital Management, LLC, an SEC Registered Investment Adviser. Jacobi Capital Management, LLC and Jacobi Wealth Advisors are entirely separate entities from LPL Financial. Jacobi Capital Management, LLC employs (or contracts with) individuals who may be (1) registered representatives of LPL and Investment Adviser Representatives of Jacobi Capital Management, LLC; or (2) solely Investment Adviser Representatives of Jacobi Capital Management, LLC. Although all personnel operate their businesses under the name of Jacobi Capital Management, LLC or Jacobi Wealth Advisors, they are each possibly subject to the differing obligations and limitations and may be able to provide differing products or services. Please speak with your financial professional for more information or see their personnel bio pages on the Jacobi Wealth Advisors website at www.jacobiwealth.com.