Meanwhile, for potential buyers, sellers ‘things are picking up’
Higher tax rates that went into effect this year have further raised the stakes for business owners anticipating a third-party sale, as failure to plan for those impacts could surprise sellers by leaving them with significantly less in take-home pay than anticipated, according to North Bay experts in accounting and business law.
While experts in business mergers in acquisitions have long urged owners to take those tax impacts into account when planning a sale, a combined state and federal rate that currently tops out at 39.6 percent for non-investment income has made that planning even more important, they said. If included as part of a holistic approach to a sale, sellers can stand to walk away with more income and with a clearer picture of the takeaway pay that for some will be a core source of wealth that supports them into retirement.
“More often than I would like, a client decides that they are in fact going to sell their business and enter into a letter of intent. They decide the price is great, but they haven’t actually looked at it from a sale structure standpoint,” said Jay Silverstein, wealth services partner at the Santa Rosa office of the accounting firm Moss Adams. “They can end up surprised when they actually realize what they really get after tax.”
While each case varies, business owners are often less sophisticated than buyers when it comes to understanding the nuances of a sale. The decision to sell a business to a third party can be an emotional one, and simply finding an interested buyer is a significant benchmark in itself, he said.
Unfamiliar with the way sales may be treated for tax purposes, some sellers bring in tax professionals only after signing a letter of intent that outlines the basic mechanism of the ownership transfer. Even if it is found at that point that the seller could have avoided or negotiated around a significant tax burden, some are reluctant to backpedal against the immensity of the acquisition process.
“It’s like buying a car – the salesmen gets you in the car, and you’re hooked,” Mr. Silverstein said. “Once you initiate the process, a buyer can feel hooked.”
Instead, succession specialists said that sellers should do that planning early, including tax considerations as part of an addendum in a letter of intent and making those factors an integral part of discussions.
“Everybody looks at the top line. I’ve always been interested in what I call ‘The Bottom Line,’ – what they actually take home,” Mr. Silverstein said.
Third-party business sales generally occur through two mechanisms – the sale of company stock, or the sale of company assets, experts noted. Owners tend to prefer stock sales, with income taxed at the lower capital gains rate. If structured as an asset sale, income would be taxed at higher rate that is often the case for normal income.
Meanwhile, buyers typically prefer an asset-type sale, which allows them to realize a depreciation benefit for those assets while minimizing the risk of inheriting liabilities from prior owners. Some of those depreciation benefits are even available in that same tax year, said Steve Ghirardo, a managing partner at Novato-based Ghirardo CPA.
“Besides agreeing on a price overall, buyer and seller should agree on how that price is allocated across those assets,” Mr. Ghirardo said.
Agreeing on the tax treatment of the sale is also an important measure to avoid scrutiny from the Internal Revenue Service, as each sale structure involves different documentation and inconsistency between the buy and sell side can raise red flags, he said.
Regardless of the structure that is ultimately chosen, early discussion of those approaches can often lead to better outcomes for sellers and buyers alike, according to business succession experts. Yet recent tweaks to tax law, along with a generally uptick in rates, have thrown some new complications into the process.
If they weren’t already in the highest bracket, income from the sale of a business is likely to propel owners into the upper rungs of tax ladder and leave them facing higher tax burdens in the year of a sale. This leaves them likely subjects for a new 3.8 percent federal tax on capital gains for high-income earners, levied along with the now 20 percent federal rate for capital gains and California’s treatment of investment gains as ordinary income.
“Typically, people think it’s aimed at people with a lot of investment income,” said Nick Donovan, partner at Napa-based law firm Gaw Van Male, of the new health care tax. “But it also affects people who own their company.”
Combined, the state and federal rates for capital gains could exceed 33 percent, narrowing the seller-side benefit for a stock sale treated as capital gains versus an asset sale taxed at a maximum rate of 39.6 percent.
“The climate has changed a bit. If you can sell stock in your company, it’s a big jump,” he said.
The full impact of those tax bumps are still coming to light, with potential implications in strategic decisions for business ownership structure and the allocation of wealth into trusts, Mr. Ghirardo said.
“The important thing is looking at the structure of your business before your sell it, to see if there will be tax consequences,” said Mr. Silverstein of Moss Adams.
Often described as being asset-rich and cash-poor, owners of vineyards and similarly land-rich companies in wine and agriculture face common tax perils when it comes to transferring ownership, Mr. Donovan said.
Passing more than 50 percent of a land asset at once to a limited liability corporation, for example, will trigger a mandatory reassessment for property tax purposes, he said. New owners could be hit with a significantly higher tax bill, one that could be avoided if ownership is spread across multiple entities.
“If you structure it wrong and transfer too many interests, the reassessment could be very expensive,” Mr. Donovan said.
Retail operations also face some unique tax considerations, which could include sales taxes paid by the seller when new owners purchase the company’s inventory. If discussed as an early part of a sale, sellers could include that projected tax impact as part of the sale price, Mr. Ghirardo said.
Mr. Ghirardo and others noted that tax considerations are one of many elements involved in a business sale. Yet early discussions allow for better long-term planning, including the allocation of that wealth as part of a well-crafted estate plan.
“It’s just one of many factors, but to ignore it is perilous. It can represent the single largest expense of the transaction,” Mr. Ghirardo said.
Meanwhile, Mr. Donovan of Gaw Van Male said that buyers have remained interested in acquisition despite the higher rates in the current period.
“There’s a bigger factor going on – buyers are interested. Things are picking up,” he said.
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