There has been a lot of discussion recently about the changes coming in the Capital Gains tax. Some of the changes are built into current law, and there is a lot of speculation that there will be more serious changes proposed when the Congress has to consider the expiration of the current rules at the end of this year.
The situation is well described by Monty Walker in his January newsletter copied here:
Federal Capital Gain Tax Rates:
Where are they headed?
Since 2003, the top tax rate on most capital gains has been 15% for people in the 25% or higher tax bracket. Although a lower level tax rate has also been in place since 2003 for people in the 15% or lower tax bracket, this rate is only applicable until a person has enough income to cause him / her to enter the 25% tax bracket. As a result, for people incurring a capital gain from selling a business, most of them are in at least the 25% tax bracket so the top 15% rate is generally the rate they experience.
The current capital gain rates are scheduled to expire effective December 31, 2010 due to a time lapse built into the regulations associated with the 2003 gain reductions. This time phase-in is known as a sunset provision. Thus, starting in 2011, the top 15% rate is scheduled torevert to its former pre-May 6, 2003 level of 20%.
President Obama made a pledge to the American people that he and his administration would not raise taxes. Well, he was able to make this pledge with confidence regarding the tax on capital gains because the sunset provision was already going to cause the rate to increase.
The big question now is; Will the top rate only rise to 20% or will congress raise it higher?
Background:
For the past 30 years, the top tax rate on long-term capital gains has been below 30%.
The top tax rate on most long-term capital gains was reduced from around 35 percent to 28 percent in 1978 and was further reduced to 20 percent in 1981. It was raised to 28 percent in 1987, reduced to 20 percent again in 1997, and further reduced to 15 percent in 2003.
The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) extended the 15% rate through 2010. But, in 2011, the top long-term capital gain rate for most long-term capital gains is scheduled to revert back to the 20% rate that applied prior to the Jobs and Growth Tax Relief Reconciliation Act of 2003 (2003 Tax Act).
The pending tax change is well within the range of changes experienced in the last 30 years.
What to Expect
On September 25, 2009, in a letter to Representative Brian P. Bilbray (R-CA), the Congressional Budget Office (CBO) stated that when assessing the impact of the increased tax rates on economic growth, it is important to keep in mind that taxable capital gains account for a small portion of all capital income. Much capital income is paid as dividends, interest, rent, and proprietors’ profits. In addition, most capital gains are not taxable because they are held in tax-exempt accounts or are held until death. As a result, CBO does not anticipate that the pending increase in the capital gains tax rate alone will have a large enough impact on the rate of return to capital overall to change significantly the magnitude of saving and capital investment.
But the CBO did further state that higher capital gains taxes could have an additional effect by discouraging innovation and risk-taking, but there is insufficient evidence on which to base a quantitative estimate.
Congress depends on the CBO to help corroborate the financial and tax results of congressional decisions. In this case the CBO is uncertain as to the full impact to be realized by an increase in capital gain rates. This indecisiveness is exactly what Congress wants in order to support that an increase in capital gain rates will not be harmful.
Also it is important to keep in mind that with the pending Health Care Reform, people classified as wealthy will experience an additional tax levy or surtax. In the House Bill, the surtax will apply to families earning more than $350,000 a year and individuals earning more than $280,000. The surtax will start at 1 percent and rise to 5.4 percent on income exceeding $1 million. In the Senate Bill, families of more modest wealth - over $250,000 - will experience a payroll tax hike of 0.5 percent.
Take notice that the surtax in the House’s Bill of 5.4%, when combined with the Year 2011 expiration of tax cuts enacted during the Bush administration, the surtax will drive the top federal tax rate to 45%, the highest level since lawmakers rewrote the tax code in 1986. That’s right, in Year 2011, along with an increase in capital gain rates, the top federal tax rate returns to 39.6%.
As previously stated, the sunset provision on capital gains will cause the top capital gain rate to increase to 20% on January 1, 2011. When considering the financial impact resulting from the War on Terrorism and the overall increase in congressional spending, it is very likely that the issue of raising capital gain rates even higher will be introduced by some member of Congress.
Assuming a final Health Care Reform bill is submitted to the President, which it certainly appears will be happening, and likely before the end of January 2010, a person with a capital gain which causes his / her total income to be above $280,000 will already pay more that 20% because of the surtax.
So, should a person trigger a capital gain in Year 2010, such as selling a business, if at all possible?
Since most business sales include a blend of capital gain and ordinary income, when considering the known capital gain rate increase, the potential for additional capital gain increases, the pending surtax and the fact that the top federal tax rate returns to 39.6% in Year 2011, a clear answer certainly emerges.
If an entrepreneur wants to experience the lowest tax impact possible from selling his / her business, selling before the tax rates increase is the way to go.
Based on current regulations, 2011 capital gain tax rates will be at least 20% with the health care surtax likely causing some people to exceed a 25% aggregate rate. If congress decides to implement further increases, anyone who waited until 2011 to sell a business will wish they could go back in time to 2010.
If you need additional information, have questions, or need assistance navigating the sea of business confusion, call your Business Transaction Strategist, Monty W. Walker at (940) 322-5086.
Sincerely,
Monty W. Walker, CPA, CBI, BCB Walker Business Advisory Services
Lately we have had a run of customers, who would have us believe they are buyers, asking for lots of information and trying to do their due diligence on a business purchase before they make a bonafide offer.
It is often hard to know how much information you should get before making an offer on a business that is for sale. I also recognize that different brokerages treat the subject differently. Some require that a customer make an offer before they even get access to any real financial information. We don’t work that way.
We believe we have to give the customer enough information to make a reasonable judgment about the business. We most always provide financial summaries of recent tax returns or owners P&L statements. We usually provide equipment lists, and we as accurately as we can represent all the assets that are being included in the business. We also arrange visits to the property and visits with the Sellers.
However, it is unrealistic to expect a Seller to provide volumes of detailed paperwork or to allow the inspection of equipment, or to allow other professional inspections of the property, without an agreed upon offer to buy the business. For that matter, it is really a waste of the customers time to go thru all that if they don’t have an accepted offer on the business. It is also really not appropriate to have any interaction with customers or suppliers of the business before you have signed P&S agreement. Businesses have been seriously damaged by interactions between would be buyers and suppliers and customers.
We include all kinds of inspection and financial record review contingency clauses in our purchase and sale documents, and often see buyers bringing in other lawyer drafted documents with more pages than ours, so we go out of our way to let the buyer review all the facts about the business before they go to closing.
One of the main reasons Sellers hire us to handle the sale of their businesses in to protect them from any unnecessary intrusion of the selling process on their daily conduct of business, and to protect the confidentiality of the sale process. We take that duty very seriously. We must protect our clients, the Sellers.
We just ask that we and our clients, the Sellers, receive a real offer, with money on the table as a deposit to make it real and legal, before buyers ask us to start the sometimes long and laborious process of due diligence.
The following article is copied directly from the BizQuest newsletter, edited by Richard Parker (not a relative) and covers a very important topic. The original article can be viewed on www.BizQuest.com, a very valuable source of information about buying and selling businesses. Aside from the newsletter they are a major source of businesses for sale listings. See the link to their site on the left under “Business Resources”
Today’s Topic: Buying a Business with a Partner - A Marriage Made in Heaven (or Hell)
I receive a surprising number of emails from prospective business buyers who are thinking about going into a venture with a partner. Usually, it’s a family member, friend or business acquaintance. What I find astonishing is that most inquiries relate to whether or not there needs to be a formalized agreement between the parties. After all most note, the partners have known each other for many years, they get along great, and trust one another. That’s all wonderful but the answer is an overwhelming, unconditional and categorical “yes” – you absolutely must have a formalized agreement.
To give you a personal example, my brother and I owned a large company together. I would trust my brother with my life in addition to him being a tremendous business confidante. Our partnership was perfect but, if heaven forbid something happened to him or me, the last thing either of us wanted was to suddenly have the other’s spouse as our partner (even though we love our sisters-in-law). For this, and numerous other reasons, it just makes sense to have everytIt does not have to be a 50-page shareholder/partnership agreement but it must clearly spell out the necessary fundamentals. Everyone goes into a partnership all glassy-eyed and hopeful. Dreams are shared. You are convinced you’ll conquer the world together. Unfortunately, situations change. Like my first boss and late uncle once told me: “you never know a woman until you marry her, and you never know a man until you work with him”.
While you will want to have an attorney compile any agreement, a few of the issues to consider include:
Definition of ownership
Dealing with disputes
Mechanisms to dissolve the partnership
Procedures to follow and a pre-determined formula to value the business in the event of a buyout by one party
Voting rights should one partner own the majority of shares (some issues such as dilution, binding the company, selling additional shares may need unanimous consent)
Procedure to follow in the event one partner dies, becomes incapacitated and unable to contribute to the business for an extensive period of time
Above all, the agreement must be fair to both parties.
I have had many partners in the numerous companies I have owned over the years. Most were great, and only a few were disastrous. Personally, I am a huge believer in having a partner. If the combination is right you can really divide and conquer!
If you are going to buy a business with a partner here are a few things to consider:
Partnerships work best when each party brings a distinct set of skills to the equation. In other words, you should each have your own area of expertise and not simply a duplication of skills.
Just because you get along with the other party is not enough reason to go into business together.
You need to formulate a list of fundamentals in advance that you both agree any business you consider purchasing must have in place. If not, each partner will find a reason not to buy every business you review.
Understand that your personal relationship with the partner will never be the same once you’re in business together. It may get better. It may get worse. Just remember what my uncle said. In my opinion, it is never worth it to jeopardize a friendship over a business but that’s not always possible. Be mindful of it and try as best as you can to keep business and personal issues separate.
You need to share the philosophy that the business comes first before individual personal gain. If you do right by the business, the personal rewards will always follow.
Business partnerships are a lot more difficult than marriage because there’s money at stake from day one and it can really influence people. Just like a marriage, a business partnership takes work; you must have full faith in the other party, and initiatives you undertake should be for mutual benefit. Most importantly like a marriage, if there are “issues”, you need to communicate no matter how difficult it may be. You cannot sweep problems under the rug hoping they’ll go away. Just like in a marriage, problems left unresolved or ones that are too big, will cause the business to breakdown and will likely not be salvageable.
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