The prospect of the capital gains tax rate increasing from 15% to at least 20% in 2011 is real. There is also talk of personal federal tax rates increasing, particularly for the more affluent. And with mounting deficits and the government's seeming inability to make meaningful reductions in expenses, many states may have few options but to increase state tax rates-on both ordinary
income and capital gains.
Consequently, more and more accountants and financial planners are beginning to advise their clients to consider accelerating tax payments, as today's tax rates may never again be this low.
This advice is particularly relevant for business owners who may have delayed considering selling their companies in hopes that the economy will soon improve.
Well, the good news is that the economy is improving; the question is will the recovery improve so much it will absorb the likely tax increases? We fear that it will not.
Business owners should consider what effect an increase in tax rates will have on the net after-tax proceeds resulting from the sale of their business. Or put differently, they should look at the increased EBITDA (earnings before interest, taxes, depreciation, and amortization) that the business would have to achieve in order to obtain the same after-tax proceeds of a sale completed before pending increases in take rates. If the transaction could be finalized prior to the anticipated capital gains rate increase. Here is an example:
Assume the following:
· The federal capital gains tax rate is increased from 15% to 20%
beginning in 2011
· The maximum personal federal tax rate is increased from 35% to 39.6%
· The company EBITDA is $10,000,000
· The sales price multiple is 5.50 times , resulting in the sale price and
and capital gain of $55,000,000 (ignoring any basis issues for example
purposes)
As a result, the federal capital gains tax on a $55,000,000 gain would increase from $8,250,000 (15% of $55,000,000) if the sale were completed in 2010 to $11,000,000 (20% of $55,000,000) if the sale were completed in 2011-an increase of $2,750,000.
Remember, this is merely an example, please do not base your transaction at a 5.5 multiple as the actual multiple may be much lower.
Comment on this blog to let us know how the proposed increase in capital gains taxes may impact the sale of your staffing firm.
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