Watch Out! Rise in Capital Gains Tax Rate Will Cut into Gains on Business Sales

I recently attended a conference for mergers and acquisition professionals as well as private equity groups (professional investors).  I had lunch with the manager of a large private equity group that has been active in buying and selling businesses for many years.  He said that they are accelerating the sale of two of the businesses in their portfolio.  They would normally wait a few more years, but are putting them up for sale this year.  Why?  Because Obama has already indicated he will raise the capital gains tax rate if elected, maybe from the current 15% to 25%.  (He said definitely he will raise the rate, but I could not find a quote from him on the 25% rate, only indirect references in articles that say that 25% is likely the number).

It is not uncommon for 75% or more of the total gain on the sale of a business to be capital gains (depreciation recapture, non-compete agreements, consulting agreements and a few other items are taxed at normal income tax rates, but goodwill is all capital gains).  So a business owner that is has a gain of a million or more is paying $75,000 or more taxes under the proposed new rates under Obama.  That is a big difference. For larger companies, the difference is well into the hundreds of thousands of dollars.  No wonder they are speeding things up.

What I don’t know is the timing of the increase.  Hopefully if Obama is elected the new administration will not make an immediate change and maybe they will ratchet it up over a few years.  If you haven’t heard about this, I’m sure you will during the run-up to the election and if you own a business, pay attention.  You could end up working for free for a few years.  In other words, you could sell now and take home more than waiting a few years and taking a salary out of your company in the meantime.