With a new administration at the helm in the Oval Office, business owners contemplating selling their business in the near future will need to consider the impact of President Biden’s proposed increases to the capital gains tax before making any moves.

Since the early 1980s, the long-term capital gains tax has held its position at 20%, which was most recently retained by the Tax Cuts and Jobs Act (TCJA) in 2017 for income over $434,550. Complementing the preferential tax rate on long-term capital gains in the TCJA was a lowered income tax rate of 37% for the nation’s highest-earners above $518,700. Together, this has been an enticing motivator for many business owners to sell in recent years due to higher net after tax proceeds.

Potential Tax Increases

The proposed tax plan laid out by President Biden will look to revert the top individual income tax rate for taxable income above $400,000 to 39.6%. Doubling down on increases, the plan proposes to raise the long-term capital gains tax by 19.6% for those taxpayers with more than $1 million in annual income, putting the rate at 39.6%.

Impact on Deals

Higher-income business owners would face nearly double the taxes after a sale under this proposal. Most of the tax paid in a business sale transaction is at capital gains rates, regardless of deal structure as long as a business has planned effectively.

A capital gain is realized when a capital asset, such as a business, is sold or exchanged at a price higher than its basis. The basis is the business’s original purchase price or invested capital, plus commissions. When selling a business, an owner’s proceeds from the sale in excess of their basis are subject to capital gains tax. For business owners who have little basis in their business, their capital gains taxes upon sale can be quite substantial.

For example, under the current law, capital gains rates are at 20% or 23.80%. With President Biden’s proposed changes, this could be as high as 43.4%.

Plan Ahead

While it will take time for the Biden administration and Congress to pass new tax laws, there is still some concern that a capital gains hike could be retroactive to the beginning of 2021.

Before going to market with your business, you need to truly understand the value of your business and the impact of any potential tax changes on after-tax net sale proceeds. Consulting with an investment banker, like those at Doeren Mayhew Capital Advisors, to perform a preliminary business value calculation is a great place to start. They can help perform an after-tax proceeds analysis with the proposed sale price considering both current and proposed tax rates. To learn more or obtain assistance, contact us today.