Conditions
Favorable: Consider Selling Your Business Now
By: Bart A. Basi &
Introduction
The time is ripe to sell your business. In the past couple of decades business owners
wanting to sell their business faced high interest rates, high taxes, and at
times tough economic conditions. Today,
three major factors exist to provide you with a substantial value for your
business.
The three factors are the tax rules, interest rates,
and the economic environment. The
current favorable tax structure allow you to sell your business for a lower
price and carry away the same amount of money you would have, had you sold in
another year at a lower price. Interest
rates provide a similar relief. When
interest rates are down, buyers can afford to finance more. Last, but not least, the economy is in an
upswing. When the economy is in an
upswing, business values arise concurrently.
When all three factors are together, they provide for an optimal
environment to sell a business.
Tax
Consequences of a Business
The first major factor in selling a
business are the tax rules. The
tax consequences of a business sale are as important as the selling price itself. When selling a business, it is important to
know there are two types of sales. One
type of sale is known as a stock sale.
In a stock sale, stock is sold and the result is a low tax rate. The gain in this scenario is taxed only once
to the shareholders in both the sale of C Corporations and all other
incorporated entities.
The other type of sale is known as an asset sale. In an asset sale, the assets of a company are
sold. As such, the sellers must pay what
is known as “recapture” to the extent depreciation has been taken. Recapture is taxed at ordinary tax
rates. Beyond that, capital gains taxes
are assessed for the difference. If a C
Corporation is selling its assets, they are taxed not only at the corporate
level at ordinary tax rates, but also at the shareholder level as capital gains.
Though not a sale, but yet a business transformation,
mergers and acquisitions are another way to change ownership of your business. In a merger or acquisition, one business is
taken into another business or combined into another business. The result is a tax free transformation of
the business for the seller. Though
there are tax ramifications, it is possible for both the buyer and seller to
get tax free benefits.
The importance of taxes is even more important to
sales involving small businesses. Often
the owners of small businesses are not considered wealthy. When tax consequences on a business sale are large,
the effect is felt disproportionately. A
$300,000 tax burden will be felt more in a $1,000,000 sale (where the owner
walks away with $700,000 and cannot retire) as opposed to a $3,000,000 tax
burden where the owner walks away with $7,000,000 and is able to retire. The current tax and financial conditions
combined together make for a more optimistic selling environment. Therefore, it is more likely a seller will
get a higher price for a business. The
following explains why conditions are favorable to sell a business at the
present time.
Low
Capital Gains Rates
The
capital gains rates are currently 5% and 15%.
Historically, the capital gains rates have been as high as 20%. This means that capital gains will be taxed
at 5% if the combined Adjusted Gross Income of the selling taxpayer (including
capital gains) is at or below the two lowest tax brackets. The amount of capital gains at or over the
25% bracket will be taxed at 15%. These new rates produce much more favorable
tax consequences than in past years.
For
example, if a company is sold and capital gains are determined to be
$1,000,000, in this tax year, the seller of the company would pay $150,000 in
capital gains taxes as opposed to $200,000 in a past year. The result is a tax savings of $50,000 just
given the fact that the sale happened this year as opposed to a past year.
Capital
gains can be recorded in installment sales (i.e. over a period of years). In an installment sale, gain is recognized
when money comes through the door. This
means the capital gains can be reported over time. However a capital gain is dependent on the
rate of tax in the year for capital gains.
If it fluctuates, capital gains could go up. That is why it is important to consider selling
a business now. The capital gains rates will
more than likely not go up in the new few years and you will be able to use the
lower rates effectively in an installment sale.
Low
Ordinary Tax Rates
Ordinary
tax rates are also some of the lowest they have been in recent times. Since ordinary taxes usually result in business
sales of assets, sellers are at an advantage this year to sell their companies
as opposed to waiting for a future year when ordinary tax rates go up.
For
example, the top ordinary tax rate has been around 40%; now the top tax rate is
35%. Given a taxpayer has $100,000 in
ordinary gains, the taxpayer will pay $5,000 less in taxes for selling this
year as opposed to a higher tax year.
Remember, taxes can go just so low before Congress has to raise them or
increase our debt.
Low
Interest Rates
The
low interest rates of today are a bit of an anomaly in today’s market. Generally, buyers finance the amount of
principal they can with the prevalent interest rate. This can best be seen in the housing
market. Before the interest rates went
down, housing prices were still generally low.
An average American might have been able to afford $1000 per month with his
or her income. This would have financed
roughly a $125,000 house. Since the
interest rates went down, that same monthly payment can finance approximately a
$200,000 house.
The
same is generally true for business sales.
When a buyer can finance more, sellers will get more for their business. The best results can be obtained by selling
now before interest rates go back up.
A
Thriving Economy
An important consideration in valuing a business for
a buyer is attitude. If a buyer is
optimistic, he or she will pay a higher value for the business. Though we have
endured a few hard years, leading and current economic conditions indicate the
economy is in an upswing, making for a better sellers’ market. The result will be a substantial premium on a
business sold today as opposed to a business sold maybe even two years ago.
Special
Consideration for C Corporation Asset Sales
The taxes at the C corporation level are slightly
less than they have been in the past.
Additionally, it is a longstanding fact that corporations do not benefit
from the low capital gains rates from which individuals benefit. Even though this might make a sale of a C
Corporation seem bleak as far as tax consequences are concerned, such is not
the case. In the recent past, the
concept of “Personal Goodwill” has been developed. Personal Goodwill results when the owner of a
business develops goodwill outside of the company. This type of goodwill is taxed only at the
shareholder level and not at the corporate level. The result is favorable tax treatment at
personal capital gains rates. However,
since this concept is new, it may change.
Therefore, C Corporations still face high taxes to operate their
business, but may face low taxes to sell their business. C Corporation owners are advised to take
advantage of this concept before it is changed or modified.
Subchapter S corporations are taxed at the personal
level. Thus, with the personal rates
decreasing and capital gains rates of 15% applying, now is the time to consider
selling your Subchapter S Corporation as well.
Future
Tax Changes
Now
that President Bush has been reelected there will be changes. During his first term, the Administration and
Congress changed the tax code five times in four years favoring taxpayers, both
businesses and individuals alike. Being
that he is a president who wants to alter the tax code, it is inevitable the tax
code will be changed during the next few years.
Many of the current tax changes expire during the next four years. The president has or has promised to extend
these low tax rates through 2007. Then,
what happens is up to Congress!
However, President Bush is determined not to leave the
White House without cutting the nation’s deficit. To do this, he will have to either cut
spending, raise taxes or both. This
leaves the future of tax rates uncertain for the remainder of his term. The President is straddling the possibility
of changing the entire tax structure. This
possibility has been expressed in many major newspaper articles. Being that this uncertainty exists in the tax
laws; it is advisable to begin your business succession plan now and not wait.
Conclusion
From
a tax, financial, and economic perspective, now is a great time to sell your
business if you are thinking about retiring.
The tax rates are at low levels, interest rates have started to increase
and the economy is on the upswing.
Anyone planning to sell a business should do so now as long as taxes,
finances, and the economy are factors in the decision process.