Publications

Higher Taxes on Sale of Companies Looming - July 2007

By Richard E. Gregerson, President, Janas Associates.
Prepared for publication on Janas Associates website, July 2007.

For business owners who may want to sell their business entirely, or take some money off the table, 2007 and 2008 may be the last years to do so before higher taxes go into effect.

Congress is targeting wealthy individuals as a way of providing tax cuts for the middle class. There is talk on Capitol Hill and elsewhere that the capital gains tax could be increased by 33% for taxpayers reporting income over $250,000. Congress is also considering adding new top brackets for ordinary income.

The forum for these tax increase plans is the House Ways and Means Committee hearings about the Alternative Minimum Tax. During the spring of 2007, there was a call by Democrats to address the issue of the growing number of American households subject to the Alternative Minimum Tax (“AMT”). The AMT, which was enacted in 1969 and designed to levy taxes on 155 wealthy families that paid no income taxes at all, will affect 23 million taxpayers in 2007. By 2016, as many as 48 million taxpayers could be subject to the AMT.

Congress is holding hearings on providing relief from AMT to "middle class" families. To offset these tax cuts, Congress is discussing adding new top brackets for wealthy individuals and increasing the capital gains tax rate. Legislation has not yet been drafted; however, adding new brackets to the top end of income tax rates and increasing the capital gains rate from 15% today to 20% or even 25%, are most often mentioned.

President Bush would probably veto any increases in the capital gains tax; however, come 2008, a more moderate Republican President and practically any Democratic President, may see things differently.

For business owners who may want to sell their business entirely, or monetize a portion of their ownership, 2007 and 2008 may be the last years to do so before higher taxes go into effect. There is no guarantee that Congress will increase taxes, and we at Janas Associates do not profess to be experts on either taxes or politics. However, because the sale of a business is probably the biggest financial event in a business owner’s life, we do not believe in taking undue tax risks.

Every owner’s situation is different. If you are selling your company’s stock, or if you are selling the assets of an S-Corporation, an increase in federal taxes could range between 20% and 30%. For those sellers whose C-Corp is selling assets, the increase in taxes could be even more dramatic.

To get a better idea of the effect of these tax changes, let’s assume that you own a company today that is sold for a $10 million gain. Let’s assume that $8.5 million of that gain is treated as capital gains and $1.5 million is ordinary income (coming from depreciation recapture and non-compete agreement compensation). You might pay 26% more in federal taxes if you complete the transaction after Congress increases capital gains and ordinary income taxes. In other words, waiting could expose selling owners to significantly higher federal income taxes.

We are advising our clients who have an early term exit strategy to enter the market to sell now. Not only are taxes at their lowest levels, nearly every other driver of value is favorable to allow owners to get more for their businesses today. The following factors augur well for achieving maximum value for our clients’ businesses:

• Stronger earnings at client companies.
• Significant numbers of highly motivated buyers.
• Lots of cash to back buyers-$100 billion in Private Equity raised in 2006.
• Many more buyers than good companies willing to sell.
• Buying compensation is creating higher multiples of earnings-often 50% or more than just 4-5 years ago.
• Higher earnings in combination with higher multiples, have resulted in selling prices that are more than double those offered a few years ago for some Janas Associates clients.
• Tax rates are at lowest levels in decades, so sellers keep more of their record selling prices.

For more information, contact Dick Gregerson, President of Janas Associates, at (626) 432-7000.

Dick Gregerson is President of Janas Associates, Investment Bankers and Management Consultants.