Capital Gains Tax Increase - How It May Affect Exit Strategies

Most owners of privately owned businesses realize that the value of their business is strongly influenced by the earning power (profitability) of the business.  With the economic conditions that have prevailed for the last many months, the market value of most privately-owned businesses are lower today than perhaps they were a year and a half to two years ago.  Many owners can hardly wait for the day that earnings and values recover so that they can implement their desired exit strategies … and thus, many owners are looking to 2010 and perhaps 2011 for that right time.

If you are in an exit planning mode, don’t forget that in addition to the market value of your business, it is essential that you concentrate on net after tax dollars and not just be focused on achieving a high sales price.  As you may be aware, under the current Federal Tax code, how your transaction is structured for tax purposes can give you net after tax dollars of anywhere from about 85% of your sales price down to less than 50% of your sales price.  Let’s quickly do the math: if you sell your business for $2 million, your Federal taxes can range anywhere from about $300,000 to over $1,000,000!  In addition, subject to where you live, you might also have to pay State taxes.  As an example, in California you would pay another 9.3% (or another $186,000) in taxes on a $2 million sales transaction!

FEDERAL CAPITAL GAINS TAX RATES SCHEDULED TO INCREASE BY 33%

On January 1, 2011 the ‘Bush Tax Cuts’ are set to expire unless renewed by Congress. This means the Federal Capital Gains Rate will increase from 15% to 20%. So if our hypothetical $2 million transaction closes after December 31, 2010, then there will be a minimum of an additional $100,000 in Federal taxes to be paid. It would be prudent to assume that states with capital gains taxes like California will use the Federal increase as an excuse to increase state capital gains taxes, further reducing the net after tax dollars to the seller.

CONCLUSION:   While the value of your business might be greater in 2011 or thereafter, your net after tax dollars might still be greater if the transaction takes place before the end of 2010.  Prudent business owners should understand the potential impact future changes to the capital gains rate may have on their after tax dollars so they can make informed decisions on the timing of their business transition.

About The Author:  Steve Fitzgerald is a business broker in the San Diego area assisting business buyers and sellers throughout Southern California. You can reach Steve by phone at 858-320-0474.

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