By:  Michael Fekkes, CBI  - ENLIGN Business Brokers

Many business owners are re-assessing their exit plan as a result of the 33% increase in the long term capital gains rate that will take effect on January 1, 2011.  Owners and management teams have been challenged these past two years and have seen a decline in revenue and profit as a result of the sluggish economy.  For many, the expectations are for a brighter future and improved financial performance in the years ahead.  Since most valuations are largely derived by the earning power of the business, the general consensus is that a higher value will be achieved should the business sale be delayed to the future.  In many cases, the owner is solely focused on achieving the highest business valuation with little thought given to the net after tax dollars. Most business owners are reassessing this methodology given the significance of the tax increase and the impact it will have on the net after tax dollars received.   

The Jobs and Growth Tax Relief Reconciliation Act of 2003 was signed into law on May 28, 2003 and created lower capital gains and dividend rates for investors.  The maximum net capital gains tax for assets held for more than one year, under this Act, was lowered from 20% to 15% (and from 10% to 5% for taxpayers in the 10% or 15% tax bracket).  The 15% capital gains tax rate was later extended under the Tax Increase Prevention and Reconciliation Act of 2005, but the reduced rates are scheduled to “sunset” on January 1, 2011. The term sunset is a time phase-in provision which means that without further Congressional action, the previous law, including the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), will go back into effect.  The result of this sunset, on January 1, 2011, will be an effective 33% increase as the top 15% capital gains rate will revert to its former pre-May 6, 2003 level of 20%..

While there are a multitude of factors considered in a privately held business sale, the capital gains tax increase, has rose in prominence for any owner considering a sale in the near term.  For those management teams and owners who do not plan on selling for 5 or more years, this event should not be interpreted as a catalyst to rush out and sell the company.  For those owners that are considering a sale over the next 1-3 years, the impact that this tax increase has, on the after tax dollars received in a sale, could be significant, and, therefore, a detailed evaluation should be initiated by the owner to assess the specific impact that it has on the bottom line, between selling a business now or after 2011.  By analyzing the net after tax proceeds from a business sale in years 2010 through 2013, the business owner will recognize that even with a 10%-15% annual growth, and maintaining consistent earnings with a constant exit multiple, the additional value realized by the growth in income, in most cases, would be negated by the increase in the capital gains taxes.  Therefore, while the value of the business is anticipated to be higher in 2011, 2012, & 2013, the net after tax proceeds from a sale, could be less. While not all issues driving a small business sale are financially related, this topic will be one of many issues to consider when developing the exit plan. The goal of this article is create an awareness of the impending increase and the affect that it will have on many business sale transactions.  Business owners are encouraged to fully understand the impact of the upcoming capital gains tax increase so that informed decisions can be made in maximizing the net after tax dollars in the sale of their company. It is recommended that a business tax advisor be consulted as the tax impact will vary for every business based upon the structure of the transaction and the type of assets being sold. 

Michael Fekkes is a Senior Broker at Enlign Business Brokers in Nashville, TN.  Michael is a Certified Business Intermediary CBI®, a member of the International Business Brokers Association IBBA®, as well as a former business owner.  He can be reached at 615.535.1150  or mfekkes@enlign.com.  Enlign Business Brokers (www.enlign.com) is a Professional Services Firm serving the Southeast that is headquartered in Raleigh, NC with regional offices in Nashville, TN and Atlanta, GA. providing business intermediary services ranging from valuation and sale to exit & succession planning strategies.