“Windows of opportunity open then close. By staying in the present, handling what’s in front of us, and riding the wave of opportunity when it comes, we follow the natural order of things.” – Dan Millman (American author and lecturer in personal development)
Would you rather pay a 20% tax or be taxed almost double that at 39.6%? This is by no means a trick question as most of us would very quickly choose to pay a 20% tax as opposed to a 39.6% tax. However, the rhetorical question posed above is one that many funeral, cemetery, and crematory owners will have to practically answer or have this question answered for them when selling their business…because the window of time for those wanting to “ride the wave of opportunity” and not have to pay the higher tax is closing. And it’s closing quickly.
So, what are we talking about here when it comes to 20% versus 39.6%? We are talking about the capital gains tax. Capital gains taxes are charged on a different type of income from ordinary income of business profits. If you own an asset for less than a year prior to selling for profit, it is considered a short-term capital gain and is treated like ordinary income based on your tax rate. If your asset is owned for longer than a year before being sold for profit, it would be considered a long-term capital gain, and it is currently taxed at a maximum of 20%. Capital gains taxes are often discussed and applied to stocks and investments. However, capital gains taxes also apply to the sale of a business since capital assets are being sold.
So, what does this mean to you? It means that when capital gains taxes most assuredly will increase (from the current maximum 20%) to 39.6% in 2022 under the Biden administration’s plan, you will be paying almost double the tax on the sale of your business. Without going into the process complexities of netting identified assets versus liabilities, write-ups, allocations, goodwill, etc., here is a brief illustration of this effect:
- This simply assumes $1 million in taxable capital gains in order to apply the maximum overall capital gains rates for current year 2021 versus proposed rate 2022 in the first two columns.
- The third column is meant to show how you would have to numerically improve your business’ worth in order to yield the $1.33 million capital gain so that your take home amount would roughly be the $800,000 you would have taken home under a 20% capital gains tax rate at $1 million gain. You would have to functionally grow your business well over the 33% increase in taxable asset value if $800,000 was the goal you financially set to have in the bank.
If you sold your business and would enjoy $2 million in taxable capital gains, the numbers would look like this:
Of course, the scenarios above are high-level and simplified, meant to demonstrate an overall impact of a changed tax rate. But as funeral, cemetery, and cremation professionals and as owners who know how difficult it is to grow revenue, I am sure you can see the leveraging effect and feel the burden of having to grow your business in order to yield enough of the taxable assets so that you achieve your take home goal in light of potentially missing out on a lower 20% capital gains rate.
What makes it even more complicated is that the IRS will consider and treat each individual asset (i.e. land, building, inventory, vehicles, etc.) even when a lump sum is paid for all business assets. And then there are things to consider such as how a Purchase Price Allocation (PPA) accounting entry could materially affect the IRS’ treatment of your individual assets. There are ways to work through the PPA that may result in minor favorable tax treatments for you. However, none that will overcome the material effect of almost doubling the capital gains tax rate. But this is getting deep and long into the complexities for which this writing was not meant to do.
Simply stated, if you have been thinking about selling your business, your window of opportunity for taking advantage of a lower capital gains tax is very quickly closing for 2021. In most instances, if the proverbial ball isn’t already set in motion by the end of August 2021, your sale very likely will not close in time by the end of the year. And even if Biden’s tax proposal does not pass until the middle of 2022 or later in the 2022, it can easily be ratified to retroactively apply January 1st. Do not let indecision or inaction cause you to miss your 2021 window, and you must pay the price of doubling your tax burden in 2022.
The Foresight team can help you get it done in 2021. We can even help you through all the complexities mentioned above but not explored. And of course, we can help you navigate 2022 and beyond.
“We all have neglected opportunities to deplore.” – Sir Arthur Conan Doyle (author of the Sherlock Holmes books)