For business owners selling their businesses, it’s not what is made on the sale, it’s how much that is kept after taxes that matters. This “net net” number is a critical number to know if an owner is deciding if he or she is ready to sell, and it can only be accurately calculated by an owner’s tax advisors. I’m an intermediary, not an accountant, so I don’t give tax advice. But I do listen to what owners tell me their accountants have cautioned them about.
With the disclaimer that I’m not giving tax advice behind us, let’s get to the heart of the matter:
Owners considering the sale of their business in 2021 should get started now. The average sale takes 7-9 months, and there is a high probability that waiting to sell in 2022 will result in a significantly higher tax bill, negating the benefits of waiting for a higher purchase price.
What is Capital Gains Tax?
When an asset such as a business is sold, tax is owed on the difference of the sale and the book price. Book price is another accounting term, but it’s basically what an owner invested in the business. Capital gains tax can be short or long term, long term meaning an owners had a business for more than one year. Here’s a theoretical example:
Bob starts his business investing $300K. Years later he sells it for $1M. He’s got a $700K capital gain. A long term capital gains tax of 15% would be a $105K tax bill due in April when he does his taxes in the following year. Bob nets $895K from his $1M sale.
What is the current Capital Gains Tax?
According to NerdWallet.com, the 2020-2021 capital gains tax rate is between 0-20%, depending on an owner’s status of being married and income brackets, but for the majority of owners it’s going to be 15%. You can see the full chart here.
What’s going to happen to Capital Gains Tax rates?
We have a new administration and Biden’s tax plan has been published. A broad generalization is that Democrats tend to raise taxes, and Biden’s tax plan calls for, among other things, long-term capital gains tax rate of 39.6 percent.
What happens for Bob?
In our hypothetical example, if Bob feels that he could get $1.2M if he waits to sell in 2022, it’s likely that Bob could owe 39.6% on his $900K capital gain ($1.2M-$300K) which would be over $350K. In this scenario Bob works an extra year but nets just over $850K from his $1.2M sale; about $50K less than what he could get if he sold in 2021 for $1M. Bob’s better option is to sell in 2021.
There are many factors including deal size and deal structure when calculating tax exposure, but the big takeaway is that owners can expect to see a larger portion of the proceeds of their sale going towards taxes after 2021 for many years.
If you are considering the sale of your business, ask your accountant what a ballpark capital gains tax payment you may expect if you sold this year, and then ask what it may be next year. Then call me to sell your business in 2021.