Mergers & Acquisitions: Consider tax implications

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Wednesday, September 9, 2020

Q. Would a change to capital gains tax impact the sale of my business?

A. Yes, potentially a lot.

You have a solid business you’ve built for years, maybe decades. You’ve thought about a sale in the near-ish future. Considering the implications of possible tax increases on net proceeds might move up your timetable.

Regardless of who wins in November, I think we can agree the need to pay for 2020 Covid spending and other government overruns will put tax increases on the table, including long term capital gains (LTCG).

Current code taxes long-term capital gains at 20%. Without getting political, the Biden campaign proposes “taxing investment gains the same as earned income” and returning marginal rates “to historical levels.”

Historically, LTCG have been at 25%, 27% and even 35% more often than they’ve been 20% or lower. It’s plausible to think we could see rates at 25% or higher, possibly as soon as 2021. 

Let’s assume ABC Company has $2M EBITDA, $2M basis, and sells for $10 million.  Even an increase to 25% costs $400,000 more tax, or requires a 6% greater purchase price for net proceeds parity. If LTCG rates went to 35%, the additional tax is $1.2M. That’s like working seven months for free just to pay the extra tax.

The urgency to take advantage of current rates is highest for owners looking to sell in the next year or two anyway, and whose earnings growth is relatively flat. If you have earnings growth or a longer time horizon, net proceeds in the future should outpace a tax increase.

Asset sales would face similar consequences if the depreciation recapture rate increases from the current 25% to ordinary income levels.
Please consult your tax advisor. This is only an example to consider timing of a sale. 

Samantha Lincoln is a managing director at Paragon Ventures. Reach her at 415-786-8153 or slincon@paragonventures.com.