April 22 Update: As anticipated, Bloomberg reports that Biden is proposing to increase the capital gains tax top rate to 39.6%, plus the additional 3.8% surtax on investment income. This would raise federal tax rates for wealthy investors to as high as 43.4%.
Key Highlights:
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Biden Administration seeks to increase capital gains tax from 20% to as much as 39.6%
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Several states also eyeing similar increases
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Many business owners are considering an early 2021 exit to get in under existing tax rates
According to federal tax experts, an increase in the capital gains tax isn’t a question of “if” but “when,” leading many business owners to look for an exit strategy in 2021.
“The top rate will never be as low as it is this year, and because of this now is a good time to sell,” said Sidney Kess, CPA, J.D., LL.M, a nationally recognized tax expert and author of hundreds of tax books. “If you have a capital gain now, you are going to pay 20%. You’ll want to get it in as quickly as possible, assuming (an increase in the capital gains tax) will be effective at the day of the enactment.”
Currently, the US federal tax rate for investments held for a year or more maxes out at 20%, which is significantly less than the top rate for wages and salaries. For individuals earning $200,000 or more and couples earning $250,000 or more, capital gains are taxed an additional 3.8%.
However, the Biden Administration has proposed an increase to the capital gains tax rate to meet the top income tax rate. That’s currently 37%. Keep in mind that those with incomes of $1 million or more would likely be subject to a higher rate of 39.6%.
Source: The Motley Fool
Additionally, most states also have capital gains taxes that are expected to increase alongside the federal tax rates. (Currently, Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming are the only states without a capital gains tax.)
While it’s too soon to say exactly what the increase to the capital gains tax will be, business owners who are even considering an exit should consider the potential impact of delaying a desired sale.
“Someone who has invested a great deal of time, effort and funds into developing their business wants to see as much profit as possible from their work. They want to avoid the capital gains tax as much as possible,” said Thomas Smale, FE International CEO. “As always, timing is everything. Congress hasn’t started looking at specific legislation just yet, so a business owner who starts the process now will likely be able to come in under the existing rates.”
Smale added that the M&A firm has seen an uptick in clients preparing to divest in early 2021, and that he is advising business owners who are even considering an exit down the road to closely monitor the situation.
“More owners are coming to us asking for a free valuation of their business, saying they want to have this information ready in case of a tax increase,” he said. “We also have many clients who have waited for years to sell who have decided that now is the time to exit.”
Owners can find out what their SaaS, e-commerce and content businesses are worth by getting a free valuation through FE International. For more information on selling a business with FE International, check out FE’s overview of the seller process and seller FAQs. You may also be interested in reviewing this blog post highlighting what taxes are involved when selling an online business.
Disclaimer: The information contained in this article is not intended to be and does not constitute financial advice, investment advice, tax advice, legal advice or any other advice. You should not make any decision, financial, investments, trading or otherwise, based on any of the information presented in this article without undertaking independent due diligence and consultation with a competent financial advisor. You understand that you are using any and all information available in this article at your own risk.