The 10 Highest Capital Gains Tax States
A lot of small business owners accelerated sales of their companies into 2012 in anticipation of the new higher tax rates for 2013, but for those who are thinking of selling now, don't despair.
"There are things you can do to minimize—or with the right set of facts—eliminate taxes," says Timothy Jessell, a tax lawyer with Greenberg Traurig in Tysons Corner, Va. whose client base is people buying and selling companies. In one case, a client who is selling his consulting company will save $3.8 million in taxes "simply by filing a piece of paper," he says.
What's the tax picture if you're selling a business? The American Taxpayer Relief Act lifted the top rate on long-term capital gains from 15% to 20% and allowed the return of a gotcha provision that adds another 1.2% to the tax bite as of Jan. 1. Plus, a new 3.8% Medicare surtax (one of the Obamacare taxes) on investment income for couples earning more than $250,000 kicked in—raising the total top capital gains rate from 15% to 25%.
And don't forget that there are state capital gains taxes to contend with in 41 states—which are taxed at ordinary income rates in most states—that's up to an additional 13.3% bite in California, for example.
No wonder business owners are exploring ways to lessen the government's take. Here's help.
The ESOP Plan. If you own a C Corp., by setting up an employee stock ownership plan, you can roll over the proceeds from the sale of your business on a tax-deferred basis. You receive cash on the sale and reinvest it in a diversified portfolio (it's called a 1042 rollover after the Internal Revenue Code section that allows the move). It's basically a deferral play; you pay capital gains taxes on distributions. But if you hold onto the securities until you die, you get a step-up in basis and you avoid the capital gains tax altogether.
About two-thirds of ESOPs are used to provide a market for the shares of a departing owner, according to the National Center for Employee Ownership. http://www.esop.org/
The Qualified Small Business Stock Exception. If you sell stock that counts as small business stock, you qualify for lower tax rates: a 50% or 100% exclusion on gain in certain circumstances. The trick is meeting the definition, easier if you set up a business with that in mind: you can't be in the services business, for example. But it's possible to separate out part of an existing business that would count and treat it as a separate business.
Jessell has a client, a computer hardware reseller, who is considering spinning out the computer hardware portion of his business, separating it from the services side of the business, so it counts as qualified small business stock when he sells later this year.
Convert A C Corp To An S Corp. This is how Jessell's consulting company owner stands to save $3.8 million. While the 3.8% Medicare surtax pretty much always applies when you sell a C Corp., if you convert to an S Corp. and you're an active business owner and sell your stock in the business, you don't pay the 3.8% surtax. In this guy's case, his business tax year ends Oct. 31. He'll switch to S Corp. status in November, sell the business which is worth $100 million, and voila, no surtax.
That's $3.8 million in tax savings. "He said, 'Geez! Why didn't anyone else say this to me?'" Jessell says.
Can't say we didn't tell you.