When preparing for an exit, it is important to know how the recent tax law changes will affect your take home pay. Equally important is knowing how that wealth will transfer to heirs and future generations. Taxes play a crucial role when planning your exit and making decisions. Therefore, it is important to understand how the recent compromised agreement in Washington, D.C. – titled the American Taxpayer Relief Act of 2012 (or ATRA) – may impact your business exit. We have put together the salient points of the new legislation that will likely impact your exit transaction and your future financial legacy.
Ordinary Income Tax Rates
It is important to know what income would push you into the higher tax brackets, where these changes will impact your take-home pay and what type of options you have within your organizational structure. It is likely that you have a combination of W-2 (payroll) income that you take from the business each year as well as profit distributions. It would be very helpful to know your projected income (and associated tax rate) post-exit so that you can accurately forecast your taxes and net income when you complete your exit. Ordinary Income Tax Rates increased for those making $400,000 (for singles) and $450,000 (for couples) or more, and will now be taxed an additional 4.6 percentage points bringing the new rate to 39.6% (from 35%.)
Capital Gains and other Investment Income
Heading into the recent negotiations in Congress, there was a lot of speculation as to where this low capital gains tax rate would settle – some even speculated that it could go away all together with future [otherwise] capital gains transactions simply being taxed at ordinary income rates. The ‘sunset’ provision that was in place would have raised the rate from 15% to 20%. In fact, that raise did happen but, again, only for incomes exceeding $450,000. Businesses selling via a stock sale (not an asset sale) have the opportunity to be characterized as a capital gains transaction. Over the past decade, those who have bought and sold securities have enjoyed the benefit of the low capital gains tax rate of 15%. [NOTE: the long-term capital gains tax rate applies to holdings of more than 12 months.]
As mentioned, the sale of your business will likely be characterized as a capital gains transaction if you are able to sell the stock. [NOTE that many smaller transactions (i.e. under $10 million in transaction value) are often structured not as ‘stock’ purchases, but as ‘asset’ purchases – again, consult with your tax professional to determine the applicability of these characterizations to your current or future transaction].
Gift and Estate Tax Limits
There is a $5.25 million limit, per person, for estate tax purposes. Although there had been a lot of talk about a limit of $3.5 million, surprisingly the $5.25 million estate limit was maintained adjusting for inflation. Further, a $5.25 million gift limit was also maintained, adjusting for inflation, allowing families/owners to transfer as much during their lifetime, without tax, as they would otherwise do at death. The gift limit was a surprise as most expected this limit to revert to $1 million. So, for example, business owners who want to transition a portion of their business to their children can do so at the new higher levels, reducing the overall gift taxation on the estate.
In the final assessment, the American Taxpayer Relief Act of 2012 fulfilled the expectation that taxes would be going higher. The upside is that we now have some level of certainty as to where the rates will be in the near future so that we can prepare accurate forecasts and longer-term models. If you are a business owner who is considering an exit transaction, we encourage you to seek tax and legal counsel to confirm how the new rates will impact your post-exit.
Contact Opus Consulting Group to learn more about your optimal exit strategy.
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