Upcoming Tax Law Changes To Consider When Selling Your Agency
By Jon Persky, CIC, CPA, PHR
(This article, in part, originally appeared in the Spring 2011 issue of Resources magazine and is reprinted with their permission).
When you sell your agency, will you get enough money? The typical person needs to earn 70%-80% of his pre-retirement expenses to maintain his/her lifestyle in retirement. And while you probably have already put some money away for retirement and will collect social security, for the typical owner, the agency is the largest asset on his or her personal financial statement. Therefore, it's critical to maximize the amount of money you put in your pocket after paying Uncle Sam.
Change in Tax Laws In December 2010, Congress extended the Bush Tax Cuts. This leaves the capital gains tax rate at 15% through December 31, 2012. On January 1, 2013, the rate goes up to 20%. What many people fail to realize is that on January 1, 2013, there is also an additional 3.8% tax on unearned income (which includes capital gains). This 3.8% tax applies to capital gains in excess of $250,000 for a married couple or $200,000 for an individual. This tax is to help pay for national healthcare.
Let's say that you started your agency from scratch, you are married, and you can sell your agency for $1,250,000. If you sell by December 31, 2012 (and pay tax on the entire sales price), you will pay $187,500 ($1,250,000 x 15%) in federal taxes. If you sell on or after January 1, 2013, you will pay $288,000 [($1,250,000 x 20%) + ($1,000,000 x 3.8%)]. As it stands now, a one-day delay in selling your agency will cost you over $100,000 more in federal income taxes!
IRS rules allow the offset of capital gains with capital losses but limit taxpayers to deducting only $3,000 per year in capital losses that exceed capital gains. Due to the swings in the stock market over the past several years (as well as the past month), many taxpayers have significant capital losses. These losses can applied against any capital gain resulting from the sale of the agency, thereby reducing the tax due on the sale of the agency.
When to Sell? While some agency owners want to work until they die, most would like to enjoy retirement. But when should you retire? Work the numbers backwards. If you want to be totally retired in five years (e.g. move to Florida and go to the beach or play golf every day), you will need to sell your agency much sooner.
Assuming you have a commercial-line-focused agency and you control many of the key accounts, the typical buyer will want you to stick around for at least two years. The average time it takes from the day you are actively negotiating with someone to the day the deal closes is six months. And you should build in another six months to put together your agency profile (the package to present to interested buyers), come up with a list of potential buyers, and get the non-disclosure agreements signed. So if you want to be totally retired in five years, you should start the selling process in two years, leaving three years to complete these steps. But if you want to take advantage of the current low tax rates, you need to start the process now! If you wait until the beginning of 2012 to start looking for a buyer and the process takes longer than usual or if a buyer falls through at the last minute, you lose. Also keep in mind that most owners thinking about selling will procrastinate until the start of 2012. That means a higher supply of agencies for sale in 2012 than 2011 which could mean a lower price for your agency. Timing is everything.
The Issues While most people focus on price, other issues can be just as critical: Payment Term If the sale is an all-cash deal, the transaction is recognized in the year it occurs. But if payments are made over time, the seller has the option to record the income on the date of the sale, or record the income as it is received (installment sale). A careful analysis of the projected tax rates should be done to determine which is the most advantageous.
Asset Sale vs. Stock Sale The vast majority of agency sales are asset sales. This is done so that the buyer: 1) can amortize the purchase price over 15 years, 2) is just purchasing the book of business, and 3) is not assuming any liabilities.
As long as the seller is anything other than a C corporation, there isn't a problem. However, if the seller is a C corporation and the deal is structured as an asset sale, the seller could be subject to double taxation. The seller sells the assets of the corporation and the buyer writes out a check made payable to the agency. This is income to the agency. Since C corporations, unlike other business entities, have to pay income taxes, this income will be taxed. Currently the highest marginal Federal tax rate is 39%.