Richmond, VA – (October 31, 2011) We have all heard the saying that “nothing is certain in life but death and taxes.” For business owners who are looking to retire in the next few years, either one severely impacts their planned exit and retirement outcome. The first is obvious, but hopefully will not happen and is probably out of the owner’s control if it does. But not so obvious, and which can be managed by the business owner, is the impact of changing tax laws on the sale of their company.
The Bush tax cuts that generally lowered tax rates had sunset provisions making them expire at the end of 2010. This included a reduction of the individual’s capital gains tax rate from 20% to the current rate of 15%. As you know, through great political pressure brought on by conservatives in Washington, President Barrack Obama extended the sunset for two years, making the expiration date December 31, 2012. Thus without extraordinary action and unexpected legislation from the current Congress and White House, the federal capital gains tax rate will return to the 20% level on January 1, 2013. On top of that, capital gains will be subject to an additional 3.8% Medicare tax imposed by Obama’s health plan, resulting in a total capital gains tax rate of 23.8%. Of course, tax rates can change even further over the next year or two, but it is very unlikely that they will decrease.
As we consider and project future tax rates, it is helpful to review historical capital gain rates. The top federal rate on long-term capital gains was reduced from 35% to 28% in 1978. Over the next 25 years, the rate see-sawed between 20% and 28% before declining to the current 15% rate in 2003. Given the Super Committee’s debt reduction mandate and the discussion of the “Buffet Rule” which arguably involves increasing tax rates on capital gains and dividends, another extension of the 15% long-term capital gains tax rate seems unlikely.