Selling a Business: The Tax Man Wants More!
3 July 2023: Selling a Business: The Tax Man Wants More!
Selling a business – even a small one – has always involved some level of tax liability. Wise business owners and those with knowledgeable advisors generally prepare in advance by not only budgeting for the tax in their plans for their post-closing life but also when considering how to structure the transaction so they can keep more of what they’ve earned.
Unfortunately, governments everywhere – at the federal, state/provincial and local levels – are all trying to grab more and more of our and our clients’ hard-earned money to fund essential government services such as, for example, the U.S. government spending $2.6 million in advertising to encourage Chinese prostitutes to drink responsibly. (See item 7 here.)
When clamoring for more of our dough, one of government’s favorite, although bogus, claims is that “the rich don’t pay their fair share”. (Of course, no one ever defines what “fair share” means other than the implicit “more”.) The government’s remedy to this is to increase taxes on the rich – the most productive members of a society – and most recently the favored mechanism in the U.S. is to spike the capital gains tax. Herewith a case study.
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Last year, the state (Commonwealth) of Massachusetts passed what is known as the Massachusetts Millionaires Tax (MMT). This law imposes a 4% surtax on incomes or capital gains over $1 million. This surtax will affect high-income taxpayers annually and will affect some taxpayers on a one-time basis as a result of certain events, such as upon the sale of a business.
For someone who started a business 10, 15 or 20 years ago, having a gain at sale of $1 million is not at all uncommon. Massachusetts already taxes income and capital gains at 5%. Everything over $1 million will now be taxed at 9%, one of the highest state tax rates in the country.
Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
So, the first question is, what can our clients do? But another question is, how can we help?
We aren’t tax advisors and I suspect few of you scholarly and well-read readers are so we can’t give specific tax advice, We can, however, explain to our clients the importance of knowing what the tax hit is likely to be when they sell. We can also discuss – in the guise of explaining the selling process – that there are ways of minimizing or even avoiding this tax-man over-reach. Most of these strategies involve spreading the income over several years, dividing assets and their income within the family to alleviate the tax impact on the main income recipient or changing the tax jurisdiction.
Spread the Income Out
The Massachusetts law specifies that the additional tax is per tax return filed with income in excess of $1 million. Therefore, a married couple could spread out the income by filing separately, thereby having $1 million each of income, or $2 million total, that does not pay the additional tax.
Are the kids employed by the business? Depending on the seller’s estate planning, ownership of the business might be diluted by providing some equity to them.
(The Brokers Roundtable℠, an online community created and hosted by Worldwide Business Brokers, has scheduled a live interview with Roland Davis, of Davis Business Appraisers. We’ll be discussing the ins and outs of business valuations and equipment appraisals including what’s needed for a business valuation and how a valuation can be used when marketing a business. Be sure to join this informative discussion – 3.00 PM (Eastern/New York) Thursday, 20 July. At the conclusion of that discussion there will be a Q&A during which attendees can get their questions answered by a pro. But you’ve got to be a member to attend. You can sign up for The Brokers Roundtable℠ here.)
Another way of avoiding or at least reducing this liability is to spread out the payments over several years. This is especially useful when selling a business.
There are two ways to spread out the payments. One is to enter into an Installment Sale agreement, where the buyer pays the sale price over several years. This is tantamount to seller financing which means the seller generally will earn interest on deferred amount.
The other is to transfer the assets to be sold into a charitable remainder trust which pays out the proceeds over a term of years, either a maximum of 20 years or for your lifetime. The result is that, if the payout is below the $1 million in any one year, the taxpayer avoids the tax. A trust, of course, requires the advice of a trust attorney. But the savings will very likely be many times the cost of the advice.
Combining these methods could conceivably shelter millions of dollars in gains from this onerous tax.
Massachusetts Ain’t Alone, Mate!
Bad tax ideas – in fact ANY bad idea emanating from government bureaucracies – and they’re constantly being launched – have a tendency to spread like a California wildfire, especially in jurisdictions that want or need to grow government larger and spend more and more money on essential services – such as toilet cameras.
Several state legislatures have introduced similar proposals including California, Connecticut, Hawaii, Illinois, Maryland, New York, Oregon, and Washington (the usual suspects).
A more extreme move – but one gaining in popularity with residents in states run by liberal or progressive governments – is to move. Change tax jurisdictions. Over the past two years, for example, Florida and Texas, neither of which impose an income tax, have gained residents who moved from high tax states such as New York and California.
This, of course, may not be a viable alternative for everyone, particularly those whose income will jump to, say, $3 million for the single year in which their business is sold. Kids may still be in school, relatives or aging parents nearby, friends and social involvements to be considered.
The Bottom Line
The millionaire’s tax is already a reality for Massachusetts residents and is most likely be a new reality for residents of California, Connecticut, Hawaii, Illinois, Maryland, New York, Oregon, and Washington – and possibly other states whose budgets are spiraling out of control. They need more money from their residents and they believe business owners are where they can find – and grab that money
Because business owners are likely to be hit with these onerous capital gains taxes only once in their lifetime, we want to make them aware that there are choices, albeit limited: paying the tax, spreading out their income over time or family, engage a financial planner and do some trust planning or move to a jurisdiction that more warmly welcomes business owners and entrepreneurs.
Again, we’re not tax advisors but we owe our selling clients the advice that they should seek the guidance of professionals that are.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at jo*@Wo*******************.com.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at jo*@Wo*******************.com