By Dave Kauppi, President MidMarket Capital
If Biden’s tax plan is passed in 2021, it likely will be implemented in 2022. The purpose of this article is to present an analysis on the after tax proceeds a business seller would realize by selling their company in 2021 versus 2022.
I once read that the payment of taxes could be compared to the use of a toll bridge. So you have a choice. You can drive thirty miles out of your way to your destination or use the toll bridge, save the time and pay the $5 toll. In terms of paying taxes, you can take legitimate actions to reduce your taxes as long as those actions fall within the tax laws. For our purposes here, your choice is to move your sale timeframe up to 2021 from 2022 or shortly thereafter.
Now you may not have planned to sell your business in 2021, but once you look at the quite dramatic difference in your after tax proceeds, you may want to consider moving up your sales timeframe. Consider this analysis:
Assumptions Sell in 2021 Sell in 2022
Business Selling Price $10 Million $10 Million
Long Term Capital Gain Tax Rate Federal 20%* 39.6%*
Long Term Capital Gain Tax Rate State 6% ** 6%**
Short Term Capital Gain Tax Rate Federal 37%*** 39.6%***
Short Term Capital Gain Tax Rate State 6%**** 6%****
* The biggest change is raising the Federal Long Term Capital Gain Tax Rate from its current Max of 20% to the new 39.6%, the same as the top proposed income tax rate.
**The Long Term Capital Gain Tax Rate varies from State to State from a high in California of over 13% to New York at 8.8%. The LT Capital Gain Rate is generally the same as the state income tax rate. So for our example we will use 6%.
***The Short Term Capital Gain Rate Federal will be raised from the 2021 rate of 37% to the proposed 2022 rate of 39.6%
**** The Short Term Capital Gain Rate State again varies and normally matches the state income tax rate. Most states do not make the distinction between short and long term capital gains for tax purposes.
Category Sell in 2021 Sell in 2022
Total Transaction Value Pre Tax $10 Million $10 Million
Long Term Capital Gain on Sale $9 Million $9 Million
LT Capital Gain – Tax Due Federal $1.8 Million $3.564 Million
LT Capital Gain – Tax Due State $540 K $540 K
Short Term Capital Gain on Sale $1 Million $1 Million
ST Capital Gain – Tax Due Federal $370 K $396 K
ST Capital Gain – Tax Due State $60 K $60 K
After Tax Proceeds $7.23 Million $5.44 Million
Difference between 2021 and 2022 $1.79 Million
Given this backdrop, what is a business owner who is anticipating selling his/her business in 2022, or 2023, or 2024, to do? Move up your sale timeframe, but not necessarily your exit timeframe. No, I am not talking in riddles. What I mean is that you should take your chips off the table with a sale transaction sooner rather than later. Your eventual exit could be in 2022 or later, after working full time for the new owner for a 1 year period to transition customer relationships and intellectual property, followed by a limited consulting engagement for two years.
Too many business owners view their business sale and their retirement as a simultaneous event and end up delaying the sale to the day they want to stop working. That mis-perception can be very costly, especially with this impending serious tax hit. Too many owners wait too long and end up selling because of a negative event like a pandemic, financial meltdown, health issue, loss of a major account, a shift in the competitive landscape, or just plain burn out. As you can see, none of these major reasons for selling puts you in a favorable negotiating position. Since it normally takes 6 months to complete a business sale and we anticipate a rush to the exits once a large number of business owners recognize their tax cost of delay, we are recommending you start the process as soon as you can.
Dave Kauppi is the editor of The Exit Strategist Newsletter and Author of Selling Your Software Company – An Insider’s Guide to Achieving Strategic Value Dave is a Merger and Acquisition Advisor and President with MidMarket Capital, Inc. MMC is a private investment banking, merger & acquisition firm specializing in providing M&A sell side representation to entrepreneurs and middle market corporate clients in information technology, software, high tech, and a variety of industries. Dave began his Merger and Acquisition practice after a twenty-year career within the information technology industry. His varied background includes positions in hardware sales, IT Services (IBM’s Service Bureau Corp. and Comdisco Disaster Recovery), Software Sales, computer leasing, datacom, and Internet. The firm counsels clients in the areas of merger and acquisition and divestitures, achieving strategic value, deal structure and terms, competitive negotiations, and Letter of Intent Consulting. Dave is a Certified Business Intermediary (CBI), is a registered financial services advisor representative and securities agent with a Series 63 license. Dave graduated with a degree in finance from the Wharton School of Business, University of Pennsylvania. For more information or a free consultation please contact Dave Kauppi at (269) 231-5772, email davekauppi@midmarkcap.com or visit our Web page MidMarket Capital, Inc.