The Impact of the Coming Tax Hikes on Capital Gains and Income

The Impact of the Coming Tax Hikes on Capital Gains and Income

By John Hammett

June 18, 2010

Do you really understand the impact of the coming tax hikes on capital gains and income?

Our office has been working on a five-year business plan for a client that has really exposed the impact of the tax increases coming in 2011 and 2013.

Not only are increases in capital gains taxes going to take a bigger bite out of the proceeds of the sale of a company, but coming increases in income taxes and health-care taxes will take a bigger bite out of the income to owners who continue to own their companies.

We are all aware that the expiration of the Bush Tax Cuts will increase capital gains rates in 2011. For a company owner who is a resident of Minnesota, this will cause a 6.5% reduction in the after-tax proceeds the owner will take away from a sale.  Not everyone has noticed that the new Health Care bill also increases capital gains beginning in 2013.  When this kicks in, owners will take home 11.4% less compared to today’s tax rates.  This means that the company must be worth 6.5% more next year and 11.4% more 2 years later, just to stay even.

Fewer owners have realized that the expiring Bush Tax Cuts will reduce their annual after-tax earnings starting six months from now. For Subchapter S and LLC companies, higher income tax rates in 2011 will reduce after-tax take-home by 8.3% for a typical Minnesota owner. When the additional Health Care increases kick-in, the additional tax bite on annual earnings will reduce the owner’s take home by a significant 15.3%.

Tax rates should not be the sole driving force behind strategic business decisions, but the changes coming should not be ignored. When capital gains taxes are set to take 7% and 11% bigger bites out of cash to the owner on a sale, this needs to be considered in planning. When income taxes are lined up to reduce take-home earnings by 8% to 15%, owners need to be prepared for lower annual cash distributions from their companies. Owners need to include these factors when deciding whether and when to sell their companies.

posted by John Hammett