LONG TERM CAPITAL GAINS TAXES SUNSET IN 2011
By: Michael Fekkes, CBI - ENLIGN Business Brokers
Long term capital gains tax will increase by 33% on January 1, 2011. Although there are many issues involved in selling a privately held business, the magnitude of this increase and the affect that it will have on after-tax dollars in a business sale highlights the importance the role of timing has in maximizing the value of a business sale transaction.
In May 2003, The Jobs and Growth Tax Relief Reconciliation Act of 2003 was signed into law by President Bush. This 2003 tax law created lower dividend and capital gains rates for all investors. Under the 2003 Act, the maximum net capital gains tax for assets held for more than one year was lowered from 20% to 15%. The reduced 15% tax rate on capital gains, previously scheduled to expire in 2008, was extended through 2010 as a result of the Tax Increase Prevention and Reconciliation Act of 2005 and is now scheduled to “sunset” at the end of 2010. The term sunset is a time phase-in provision which means that without further Congressional action, the previous law, including the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), will go back into effect. Therefore, the top 15% capital gains rate will revert to its former pre-May 6, 2003 level of 20%, an effective 33% increase.
The economic uncertainty in today’s market caused in part by disappointing financial performance across many industries, scarce credit, and a decline in commercial real estate valuations has created a challenge for business owners and management teams considering a business sale. An assessment of the trade-off between selling a business now or some point in the future needs to be performed. The capital gains tax increase of 33% in 2011 has such a profound impact on the net after tax proceeds for the majority of business sales that this issue becomes a major factor in determining the optimal time table for a sale. By analyzing the net after tax proceeds from a business sale in 2011 and comparing that to a sale in 2010, a business owner or management team will realize that even with a 15% growth per year, and maintaining gross profit margins with a constant exit multiple, the incremental value attributed by the growth in revenue and income, in the majority of cases, would be completely offset by the increase in the 2011 capital gains taxes. Therefore, while the value of the business is anticipated to be higher in years 2011 and beyond, the net after tax proceeds, could very well be greater should the business sale transaction occur prior to January 1, 2011. There are many considerations involved in the sale of a privately held business and this article is written with the express purpose of helping business owners understand the potential impact that the 2011 capital gains increase will have on the sale of their company. Understanding the impact of the impending capital gains tax increase allows business owners to make intelligent decisions as it relates to maximizing the net after tax proceeds from a business sale through the well planned timing and transaction structuring. Every business will face a different set of circumstances where the tax implications will vary based upon the type of assets being sold and the structure of the transaction and it is recommended that a professional tax advisor be involved in the process.
Michael Fekkes is a Senior Broker at Enlign Business Brokers in Nashville, TN. Michael is a Certified Business Intermediary CBI®, a member of the International Business Brokers Association IBBA®, as well as a former business owner. He can be reached at 615.535.1150 or mfekkes@enlign.com. Enlign Business Brokers (www.enlign.com) is a Professional Services Firm serving the Southeast that is headquartered in Raleigh, NC with regional offices in Nashville, TN and Atlanta, GA. providing business intermediary services ranging from valuation and sale to exit & succession planning strategies.
