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You’ve spent years building your agency, and developing your finely-crafted exit plan. Now you’re thinking of selling your agency and moving on to the next chapter in your life.
Well, if you’re planning on selling, you’d better get a move on. That’s because the taxes on any profitable business sales are scheduled to increase sharply, come January 1st, 2013.
Specifically, the so-called “Bush tax cuts” are set to “sunset,” or expire at that time, unless Congress acts. When the new year arrives, you can expect the following tax increases to occur:
- Long-term capital gains tax rates will increase from 15 percent, maximum, to 20 percent.
- Short-term capital gains tax rates will increase in tandem with ordinary income rates.
- An additional “unearned income Medicare contribution tax” of 3.8 percent will kick in, potentially affecting all investment income over and above a $200,000 per year income threshold ($250,000 for married couples). However, if you are actively involved in managing your business, this tax will generally not be in play. It will mostly apply to passive activities, such as rental income and the sale of passive income-generating assets. If you are basically retired, though, and collecting dividends from the company while not actively participating in its day-to-day operations, this tax could affect you.
Additionally, though, your business sale could also push other capital sales into the unearned income Medicare contribution tax category. For example, if you sell your business and generate a $500,000 taxable gain, and you also sell an investment property at a $200,000 gain, you will need to incur the additional 3.8 percent surtax on the entire gain from the investment property. Had you split your sales into separate years, ignoring other income, you would not have to pay the 3.8 percent tax on anything under $250,000 (again, $250,000 if married.)
- An additional Medicare contribution tax of 0.9 percent, over and above what you already pay them on income, will kick in for those posting more than $200,000 per year ($250,000 for
- The favorable tax treatment currently afforded to U.S. based corporate dividends vanishes: Dividends from U.S. based companies will be taxed the same as offshore dividends – except there’s no tax deduction for foreign income taxes. This significantly aggravates the “double taxation” issue that has historically plagued C-corporation shareholders: If you are in the 28 percent tax bracket, personally, and you take a dividend payment from your corporation, you only receive 65 cents per dollar of earnings from the dividend. The other 35 percent goes to corporate income tax. But then you have to pay income tax again on what’s left. What are you left with? 53.2 cents on the dollar your corporation earned, minus the additional 3.8 percent tax on any passive investment income over $200,000 per year, and 3.9 percent for Medicare contribution tax. Past that threshold, you keep less than half of every dollar, thanks to the combination of corporate taxes, individual income taxes, and Medicare taxes.
And then there are state income and capital gains taxes on top of that, depending on your location.
It pays, then, to complete any sale of a business or other capital asset to prior to January 1. In fact, the difference is so large that there could be a glut of agency sales as we press to the end of the year – which may be a boon to those looking to acquire agencies this year, as well.
Tax Mitigation Strategies
Hopefully, that increase to 20 percent in taxable gains from 15 percent is going to be a big problem for you. The more capital gains you have, the better.
However, you can mitigate its effects – and all but eliminate the threat of the additional Medicare levy – by structuring your business sale as an installment sale. This will have the effect of spreading your taxable investment income over a number of years. The ideal goal is to stay below the $200,000 per year income threshold (or $250,000 per year if you are married).
AgencyEquity.com or Strategic Agencies LLC does not give tax advice, this is for general information only. It’s best to consult your tax advisor as well as keep yourself informed on the latest tax laws.