Why The Government Could Get Half Your Business
Mike Periu, Director, Council for Economic Education
August 19, 2013
When you think about selling your business, how much of the sales proceeds do you expect to
keep? Many owners respond with a common answer: the net proceeds (sales price minus
liabilities), forgetting that silent partner Uncle Sam will also expect his cut. Changes in tax laws
from the implementation of Obamacare and from the fiscal cliff outcome have made his slice
The U.S. has one of the highest capital gains tax rates among developed countries, according to a
study by Robert Carroll and Gerald Prante of Ernst & Young LLP. The top long-term capital
gains tax rate, when combining both state and federal taxes for a corporation owned by an
individual, currently stands at 56.7 percent. That means if you were to sell your corporation
today for $3 million, you could walk away with as little as $1.3 million, leaving $1.7 million to
the government. The difference between $3 million and $1.3 million could just be your ability to
retire vs. having to continue working.
Over the next several years, this already high tax rate is likely to increase. At the federal level,
there's tremendous political pressure to increase long-term capital gains taxes—some
congressional leaders believe it should at least be equalized with earned income tax rates if not
made higher. Influential Senator Max Baucus, who announced his retirement earlier this year,
has made securing an increase in capital gains taxes one of his key priorities before his
retirement in 2014. If Congress is able to reach an agreement that the president is willing to sign,
we could see significantly higher long-term capital gains taxes starting as early as 2015.
But rather than leave most of the fruits of your labor to Uncle Sam when you sell your business,
consider these options:
Think about selling sooner rather than later. It’s never a good idea to make decisions solely
for tax reasons, but it’s a bad idea to ignore them too. If you're already contemplating selling
your business and you don’t expect it to accrue significant value over the next few years, you
may want to consider selling before rates increase. Even a 5 percent increase in the long-term
capital gains tax rate would mean $150,000 in additional taxes on a $3 million sale.
Evaluate an asset sale vs. a stock sale. These two options can have very different results from a
tax perspective. In an asset sale, the buyer purchases the individual assets in the company and
assigns a value to each one. The total sum of these asset prices is the total purchase price. The
IRS has very specific rules as to how the purchase price should be allocated across individual
assets. The seller is left with the proceeds and an empty corporate shell that basically owns
nothing. Buyers tend to prefer this method because it allows them to avoid potential litigation
and liabilities that may be the responsibility of the company. In addition, the buyer also has the
right to depreciate the assets based on the actual purchase price, which means that the buyer’s
future tax bill will be lower. As the seller, this type of asset sale means you may be subject to a
hefty tax bill.
The alternative is a stock sale, where the buyer pays you for the shares in the company. In this
type of sale, they take ownership of everything—the good and bad, the known and unknown.
While your tax bill may be significantly lower, buyers will also want to pay less as the risk of a
forgotten lawsuit will be present and the benefit of higher depreciation on their tax bill goes
away. You'll have to review both types of sales to see which might be better for you.
Consider—with caution—changing from a C corporation to a different legal entity. If your
business is organized as a C corp and you plan to structure your transaction as an asset sale,
you're going to be subject to double taxation. The business entity will pay taxes on the profits
from the asset sale, and you'll have to pay taxes on the proceeds distributed from the company.
Limited liability companies and Subchapter S corporations don’t have to deal with this issue.
They're considered "disregarded entities" for tax purposes, meaning you'll only pay income taxes
once, not twice. If you're planning a sale in the medium term, consider switching from a C corp
to another entity. But proceed with caution: The IRS won't allow you to reap the tax benefits of
such a maneuver if it's done just before a sale or in contemplation of a near-term sale. A
company that switches from a C corp to an S corp, for example, has to wait 10 years to capture
all the tax benefits of the switch in a sale.
Consider getting paid in buyer stock. If your company is being bought by a large, publicly
traded company in which you have great confidence, you may be able to defer your taxes
indefinitely. The IRS allows you to defer income taxes on a company sale if you're paid in shares
of the buying company. As long as a significant portion of the transaction (at least 40 percent) is
paid in stock, you can defer paying taxes until you actually sell the stock. Even though capital
gains taxes are going up, this could be an important estate planning tool if you don’t plan to use
the money from the sale of the business.
Before implementing any strategies to minimize taxes due to the sale of your business, be sure to
consult your attorney, tax specialist or financial advisor.
Wednesday, August 21, 2013
Thursday, August 8, 2013
New Financing Alternative is Not Just for Small Businesses Anymore
Some not-so-small businesses are choosing financing options originally designed to assist Main Street USA.
Aug. 7, 2013Marc Glazer
Small business lending conditions appear to have improved in recent months. In an AprilFederal Reserve Bank survey, just under one-quarter of senior bank loan officers said that lending standards for small firms had eased somewhat over the prior three months. More recently, a private sector analysis of small business loan applications reported in July that both large and small banks are granting loan requests at much higher rates than they did a year ago.
This apparent improvement in capital availability for small businesses, while welcome, is still from a dismal base. In a 2012 survey by the American Sustainable Business Council, 60% of small business owners said they have faced difficulty obtaining loans, and an overwhelming 90% agreed that the availability of small business loans is a problem.
It is not just the smaller businesses who are frustrated; even larger, more established companies continue to have trouble getting bank financing. They are turning to specific lenders that have been a source of credit for Main Street USA for more than a decade. And a few of those providers are stepping outside the industry comfort zone to respond.
Filling a Credit Gap
These finance companies started out in the late 1990s providing funding to small restaurants and retailers that could not get bank money. The terms were short and the advances rarely topped the six-figure mark. The cost was higher than a bank, but when bank loans were unavailable, the comparison proved moot for an owner who needed capital to grow.
In the easy-money era, the market for these finance companies was limited. But with banks calling loans and rejecting even good credits beginning in late 2008, an influx of small businesses sought out these sources of capital, and the industry expanded rapidly. Adding short-term loans opened up the market to non-retail businesses. Even though these lenders were financing businesses that banks would not, the industry leaders emerged from the recession stronger.
No published data exists, but it is estimated that the sector funded $1.5 billion in 2012 alone. With capital flowing in from such firms as Goldman Sachs, Google Ventures and Wells Fargo Capital Finance, some industry insiders are predicting that funding could top $3 billion in 2013.