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Selling Your Business in 2010 When Federal Tax Rates Are Still Low

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Ronald Feuerstein & Phil Jaeger
BKK Business Law Newsletter
July 2010

This is a time-sensitive alert on current long-term capital gains tax rates and the higher rates that are likely to be enacted by Congress for January 1, 2011 and beyond.

If you are thinking about selling your business, you should consider selling your business in 2010 when federal long-term capital gains tax rates are still low. After 2010, the federal long-term capital gains tax rates on the sale of your business will probably rise from the current federal rate of 15 percent to at least 20 percent and possibly higher.

During 2010, most owners who sell their business will pay the top federal long-term capital gains tax rate of 15 percent. Under the current federal income tax law, the top 15 percent long-term capital gains rate is scheduled to expire on December 31, 2010 and revert to its former pre-May 6, 2003 level of 20 percent. Given Congress’ need to raise revenues to pay for increased spending to support the economy, national security and deficit reduction, the question is: Will the top federal long-term capital gains tax rate rise only to 20 percent or will Congress raise the long-term capital gains tax rate higher?

During the past 35 years, the top federal tax rate on long-term capital gains has ranged from 35 percent in 1976 to 15 percent in 2003. The top federal rate on long-term capital gains was reduced in 1978 from 35 percent to 28 percent and in 1981 was reduced to 20 percent. In 1987, the top federal capital gains rate was again raised to 28 percent. Not until ten years later, in 1997, was the federal long-term capital gains rate reduced again to 20 percent. The lowest (and current) rate of 15 percent became effective in 2003.

What will this pending change in the federal tax law mean when you sell your business? If you sell before December 31, 2010, for every $1,000,000 in gain on the sale of your business, you will pay $150,000 (i.e. 15 percent) in long-term capital gains tax. If you sell after December 31, 2010, for every $1,000,000 in gain on the sale of your business, you will probably pay at least $200,000 (i.e. 20 percent) in long-term capital gains taxes, and would pay $250,000 (i.e. 25 percent) if the long-term capital gains tax rate increases to 25 percent.

Consider, if you sell your business for $20,000,000 above your basis before December 31, 2010, you will pay long-term capital gains taxes of $3,000,000 (i.e., 15 percent of $20,000,000) for net after-federal income tax proceeds of $17,000,000 ($20,000,000 less $3,000,000). If you sell your business for $20,000,000 above your basis after December 31, 2010, and the tax rate increases to 20 percent you will pay long-term capital gain taxes of $4,000,000 (i.e. 20 percent of $20,000,000) resulting in net after-federal tax proceeds of $16,000,000 ($20,000,000 less $4,000,000). Therefore, by selling your business for $20,000,000 above your basis before December 31, 2010, you will probably save $1,000,000 in additional federal income taxes (at a 15 percent rate vs. 20 percent tax rate on long-term capital gains) and you may save $2,000,000 in additional federal income taxes if the tax rate increases to 25 percent. If you are thinking about selling your business, you will probably do better by selling in 2010.