Capital Gains and Your Business

Capital Gains and Your Business

3/17/2024 Update: Last week, President Joe Biden announced his 2025 budget proposal. The plan calls for an increase in the capital gains tax from 20% to 39.6%, along with a package of other tax increases. While this announcement is not surprising, it highlights the need for business owners considering selling their company within the next five years to take action now. If you are in such a position, consider reading through the information we have provided below and giving one of our Pathfinders a call.

The details of each provision in Biden’s proposal can be found on the official White House website: https://www.whitehouse.gov/briefing-room/statements-releases/2024/03/11/fact-sheet-the-presidents-budget-for-fiscal-year-2025/).

The Outlook For 2025 As We Approach This Year’s Presidential Election

The capital gains tax currently remains at 20% despite efforts to double it in 2021. However, the topic gains renewed importance the closer we get to November 5th, 2024 – election night. Should the Democrat Party successfully defend its hold of the White House and Senate while simultaneously regaining possession of the House, they will once again possess all three key bodies heading into the pivotal post-Presidential-election-year legislative season. If the 2021 blueprint (described in detail below) is pursued with renewed vigor, then the issue of capital gains taxes will return to the docket, with similar increases likely being considered. Unlike last time, the tides of change may be too intense for one or two lawmakers to prevent the passing of these increases.

 

What Are Capital Gains Taxes And What Role Do They Play In The Sale Of A Company?

Capital gains are profits made from the sale of an asset – businesses, land, vehicles, and investment securities. Capital gains taxes, in turn, are the taxes imposed on those profits. Assets held for less than a year are taxed at the short-term capital gains tax rate, while assets held for more than a year are taxed using a long-term rate. The long-term rate is usually lower than the short-term rate. For example, the current top rate for the short-term capital gains tax is 37%, while the corresponding long-term rate is 20% [1].
When a business owner is contemplating the sale of their company, capital gains taxes can play a pivotal role, as they can significantly impact the after-tax, take-home pay that the seller receives. Here is how these taxes come into play:

• The Seller’s Perspective
  • When a business owner sells their company, any profit from the sale, the capital gain, may be subject to capital gains taxes.
  • The tax rate on capital gains can vary depending on factors like the duration of ownership, the country or jurisdiction where the sale occurs, and the specific tax laws in place at the time of the sale.
• The Buyer’s Perspective
  • The buyer in an M&A transaction must also be aware of potential capital gains tax implications when acquiring a business, as it affects the willingness of the seller to complete the transaction.
  • Understanding the tax status of the seller and the nature of the assets being acquired is critical. In some cases, buyers may structure deals in ways that minimize the tax impact on the seller.
• Deal Structuring
  • The way a business sale is structured can impact the taxation of capital gains. For example, a stock sale involves the transfer of ownership of the company’s shares, while an asset sale involves the sale of the company’s individual assets. These two types of sales can have different tax consequences.

It is important to note that tax laws and regulations regarding capital gains can change over time and vary from one jurisdiction to another. Additionally, individual circumstances and the nature of the business being sold can also influence the tax treatment of capital gains. Therefore, individuals and businesses involved in an M&A transaction should consult with tax professionals or experts to understand and navigate the tax implications effectively.

 

The 2021 Capital Gains Tax Increase Blueprint

The Proposal:
In the wake of the Democrats’ sweep of the White House, House, and Senate (counting Vice President Kamala Harris’ tie-breaking vote) in the 2020 elections, there were discussions surrounding radical changes to various aspects of the tax code, including the capital gains tax.
Specifically, President Biden proposed nearly doubling the federal capital gains tax rate from 20% to 39.6%. His announcement sent shockwaves through the business community as the top combined tax rate (factoring in state taxes and a 3.8% federal surtax) would have approached 50%. Rates at this level would give the United States the distinction of having the highest tax rates on long-term capital gains globally [2].

Path to Passage:
The path to passage of such a proposal, while not a slam dunk, was certainly highlighted due to certain Democrat policymakers’ belief that the wealthy weren’t paying their fair share of taxes. At the time of President Biden’s announcement, he enjoyed an eight-seat Democrat majority in the House of Representatives. Meanwhile, conditions in the Senate, while murkier, were still fairly encouraging to tax reformists – the chamber was split 50-50; however, the Democrats had the benefit of a potential tie-breaking vote from Vice President Kamala Harris.
As a result, a straight party-line vote through both chambers would have seen the White House’s doubling of the capital gains tax become a reality. Ultimately, however, the proposed capital gains tax rate increase was unable to work its way through Congress. The proposal faced challenges from key Democrat lawmakers and did not gain the requisite support to advance in the Senate.

 

Why Consider A Strategic Sale in 2024?

Imagine waking up one morning to the news that your company’s after-tax value had dropped by a staggering 25% overnight. Should the tax proposals of 2021 come to fruition in 2025, such a nightmare would become a reality.

Given the potential tax changes on the horizon, a business owner contemplating a sale of all or part of their company within the next five years might seriously consider accelerating those conversations into the first half of 2024. Depending on the election and subsequent legislative outcomes, a business owner could find the take-home, after-tax value of their company significantly reduced.

The key is urgency. Selling a company does not happen overnight. It often takes months to identify and attract the right partner who will value a company’s identity and culture.

Western’s focus is on ensuring our clients are best positioned to obtain long-term success for themselves, their families, and their companies. We believe in being proactive, not reactive. Accordingly, we are on alert for what the outcomes of this year’s federal election – and subsequent legislation, tax or otherwise – could mean for business owners.

For the business owner who is similarly concerned, there is an opportunistic window to pursue a transaction and eliminate the uncertainty of radical tax changes in the year following a federal election.

 

How Western Can Help

Western is a boutique M&A advisory firm based in Fort Worth, Texas. Our specialty is helping closely held or family-owned companies bring in outside partners or other forms of capital. Over the last twenty-five years, we have completed hundreds of deals totaling over eight billion in transaction value. In the process, we have cultivated an approach to M&A that ensures our clients are best positioned for long-term success:

• Hand-Crafted Transactions: Western does not run cookie-cutter processes or broad auctions. Instead, we work tirelessly to thoroughly understand our clients and their companies’ needs and objectives before designing a best-fit transaction. Most importantly, we seek to identify the right partner for our clients – the one who will value and respect the underlying company’s identity, culture, leadership team, employee base, and legacy.
• Relationship-Focused: Western passionately believes that transactions stem from relationships rather than the inverse. Our preferred transaction is when we develop a close, familial-type relationship with our clients that persists long after the transaction is closed.
• Hands-On Approach: When you work with Western, you get a dedicated team of talented and responsive individuals who work with you from the first day of the transaction to the last – and even beyond. We truly act as a concierge to our clients, helping them with the litany of issues that crop up – some of which don’t even necessarily pertain to the transaction at hand.
• Confidentiality: Western’s claim to fame is discretion. We take privacy very seriously. The sensitive nature of our clients’ business and their transactions are safe within our walls, and our commitment to maintaining this dynamic is unwavering.
• Independence: Western is also a family-owned business and not beholden to outside influence. This ensures that our interests are aligned with those of our clients from the first day of the relationship.

Western seeks to help business owners navigate what can be a very emotionally charged, challenging, and confusing process and bring order to it. We are only successful if the owner walks away from the transaction feeling like they did right by their family, company, employees, and legacy. Such an endeavor is not always straightforward and requires a level of care and attention that not everyone can (or is willing to) provide.

Contact us today to explore how you can take proactive steps to safeguard the long-term success of both your company and your family. Our talented Pathfinders look forward to having an informative discussion with you.

Turner Holthaus: turner@western-companies.com / 314-420-6999
Rick Groesch: rick@western-companies.com / 817-658-4653
Don Woodard III: dwoodard@western-companies.com / 817-360-8595
Western: info@western-companies.com / 817-877-9980

Sources:
[1] https://turbotax.intuit.com/tax-tips/investments-and-taxes/guide-to-short-term-vs-long-term-capital-gains-taxes-brokerage-accounts-etc/L7KCu9etn#GoTo-Capital-gain-taxes
[2] https://www.cnbc.com/2021/06/21/biden-tax-plan-raises-top-capital-gains-dividend-tax-rate-to-among-highest-in-world.html