Tax Consequences on Perpetuation Planning

Why It May Be Worth Exploring Your Selling Options in 2010

Most people who sell their assets of any type, including the stock they own in an insurance agency, will be subject to a minimum of 5% more tax if not done before 2010 year end.

The non-renewal of the current tax plan passed under President Bush is certain to happen. The current federal law for capital gains tax rates will expire on Dec. 31, 2010. With that expiration, and without any other changes, the current standard 15 percent federal capital gains rate will go to a 20 percent rate.

That change will occur if Congress takes no action on tax legislation and just lets the current law expire and resets the rates to where they were 10 years ago.

Keep in mind, with the deluge of new spending, it is fairly clear that taxes in general will go up. President Obama’s administration has sent various trial balloons out about capital gains tax cuts for businesses, if you want to believe that. However, Congress makes the tax laws and there has been no action on their part. Besides, there will be pressure to close the deficit gap and capital gains taxes are an easy target.

The Problem

How will this situation impact business owners that are within a few years of retiring and selling the business?

Most people who sell their assets of any type, including the stock they own in an insurance agency, will be subject to a minimum of 5 percent more tax if not done before 2010 year end. That is, a minimum.

Even if the business is sold in 2010, any payouts that are extended beyond 2010 are subject to that year’s tax rates.

More Problems

A second tax concern is on personal income taxes and payroll taxes. The Bush tax cuts on personal income taxes will expire at the end of 2010 and the federal upper bracket will go back to 39.6 percent.

There is also a good chance that any caps on payroll taxes will either increase or be eliminated. That is another 6.2 percent for both the employee and employer for whatever the new limit is over the current $106,800 cap.

Don’t forget the states will also have their hands out as well.

Any increase in personal income taxes will need to be factored into the sale of a business. Very often the seller will receive some of the compensation in the form of income rather than capital gains.

The lack of visible tax reform action by Congress is troublesome. Changes (if any) must be being done quietly and without a lot of publicity, to once again make the administration not look bad and to keep the panic level down. However, the lack of details creates a vacuum of uncertainty that makes it impossible for business owners to plan for the future.

All of these pending changes are happening in the middle of record unemployment levels and a deepening recession.

Many people today are feeling that they are hurting, more than any other time since the Great Depression.

Call to Action

There is a lot of gloom and doom out there. This article is not intended to add to it. The intent is to wake up any agency owner in their 60s or 70s that have not established their perpetuation plan.

Potential sellers should not wait until the inevitable happens. The inevitable being a large increase in capital gains rates and possibly ordinary income rates.

If an owner waits another year or two to start their buy-out either internally or with a third party buyer, the increase in the capital gains rate, will have a big impact on the amount of money the owner will take home for their retirement. The key to selling the business is not the sales price but the net proceeds; what the seller can put in their pocket.

The Solution – Must Grow!

If the plan is to sell in a few years, the sales price (and revenue) will need to be higher after the tax rate increases in order to arrive at the same net proceeds that one would receive in 2010. This could be anywhere from 15 percent to 30 percent depending on the actual increase in the tax rate. Growing at this rate would be very difficult in these economic times and in continued soft market conditions.

For example, if the capital gains rate goes from 15 percent to 25 percent, revenues (or sales price) would have to grow to about 13 percent in order to have the same net proceeds. If the tax rate jumps to 30 percent, the growth in revenues (or sales price) would need to be 21 percent in order to net the same amount if the business is sold today.

Summary

If you are within a couple of years of retiring and selling the business, consider taking action in 2010 instead. Converting your asset into cash in 2010 will allow you to:

• Pay federal taxes at the current 15 percent capital gains rate;
• Lock in certainty for yourself when you invest the proceeds; and
• Begin to enjoy life doing other things, during the business transition.

At least explore the sale option with your tax advisor and make an intelligent decision. Don’t delay, or you will pay.