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Tag: tax

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Your business is your baby.  You’ve sacrificed for years, nurtured, endured sleepless nights and now it’s time to sell your business.  This means income…and income means…well, taxes.   

The tax side of selling a business has many moving parts, and if you get nothing from this article…remember this!  ALWAYS consult a tax or financial advisor.   

Here are four tax-related issues to keep in mind… 

  1. Are sales proceeds taxes as ordinary income or capital gains? 
  2. Is the sale assets or stock? 
  3. All cash deal or payment installments? 
  4. Can sale be treated as tax-free merger? 

 Remember these issues are relevant for federal income taxes…different states have different rules and may collect more or less taxes than the IRS on the same deal. 

How Are Business Sales Taxed? 

The IRS, with few exceptions, treat the business as individual assets, not one big sale.   

Those assets will be put into two buckets 

  1. Long-term capital gains (real or depreciable property) 
  2. Short-term capital gains at ordinary income rates (A/R and inventory) 

 

Pro Tip #1:  Plan +2 years ahead of selling your business to reduce ordinary income tax 

If you sell an asset that you’ve held for more than 12 months, the proceeds will be treated as long-term capital gains. The maximum tax rate for most taxpayers is 15%, with the maximum rate at 20%. Proceeds treated as ordinary income are taxed at the taxpayer’s individual rate. Currently the top individual federal income tax rate is 37% more than twice as high as the long-term capital gains tax rate. 

Asset Allocation 

Obviously, sellers will want most of their assets treated as long term capital gains.  However, most times, during negotiations, the buyer may want a different allocation, that in turn, can reduce the new owner’s tax bill.   

Pro Tip #2: Negotiate on sales price, to receive a more favorable asset allocation  

It’s a potential conflict, as the buyer often wants as much of the price as possible allocated to costs that can be deducted or assets that depreciate. 

For instance, the IRS says that selling inventory produces ordinary income.  But selling capital assets held for more than a year creates a long-term capital gain. 

Deal Structure 

In addition to asset allocation, the deal’s structure can affect the tax bill. If the seller agrees to take the price in installments, for instance, they can defer paying taxes until the payments are received. 

Pro Tip #3: Buyer competent?  Doing your due diligence can spread out your tax bill 

Buyers may end up paying more when they don’t have to pay everything upfront. And the seller may also be able to charge interest, in addition to saving on taxes.  Installment sales do add more risk, though, because the new owner must run the business well enough to produce profits to make payments. 

Corporate Stock Sales 

Sales of sole proprietorships, partnerships, and LLC’s are commonly treated as sales of separate assets.  However, when a corporation is sold the deal can be presented as a stock sale rather than a sale of assets.  This is important because if the corporation sells its assets, sale proceeds will be taxed twice. 

  1.  When the corporation pays taxes and… 
  2. Again, when its shareholders file individual returns 

In contrast, a stock sale gets taxed once, saving on taxes for the seller. 

Tax-Free Corporate Mergers 

If one corporation is buying another corporation, the deal can be done by exchanging strictly stock. Under the right circumstances, this can mean no taxes at all, as long as no cash is involved. 

The Bottom Line 

No matter the size of your business, consult a financial and tax advisor as taxes can eat into the cash you were hoping to get out of your business.  All this is governed by a complex set of IRS rules, which may not always be straight-forward.    

 

INVITO

As Tax Day approaches, and before the ink dries on your check to Uncle Sam, we take a moment to look back at the history of taxes in America...you know…to make you feel better.  So, get your tea bags or some prohibition-style libations, while we reiterate the age-old saying…. nothing is certain except death and taxes. 

But before we dive in, it is important to note that taxes were not always levied on Americans such as federal income tax, the alternative minimum tax, corporate tax, estate tax, the Federal Insurance Contributions Act (FICA), and so on.  Neither did the founders of America desire and intent to design such an arrangement.   

The early colonists had to deal with the British, which imposed a bevy of taxes on the colonists including a head tax, real estate taxes, and the infamous tea tax that led to the Boston Tea Party.   

After the Revolutionary War, the Congress¬†granted¬†the power to impose taxes¬†on the public. States were responsible to collect and pass¬†those to the government, mostly excise¬†taxes imposed on specific goods like alcohol and tobacco. The government also tried direct taxation‚ÄĒtaxing things an individual owned.¬†That was not popular, and the feds went back to collecting excise taxes.¬† And in 1791, Alexander Hamilton’s proposed excise tax on alcohol was enough to prompt the Whiskey Rebellion in Pennsylvania.¬†

 

The Civil War led to the country’s first income tax and the first version of the Office of the Commissioner of Internal Revenue‚ÄĒthe earlier version of what we now call the Internal Revenue Service (IRS). This office took over the responsibility of collecting taxes from individual states. Excise taxes were also added to almost every commodity possible‚ÄĒalcohol, tobacco, gunpowder,¬†and¬†tea‚Ķbut this time‚Ķwithout the party.¬†¬†Interestingly,¬†income¬†tax rates used to apply to everyone based on income regardless of status‚ÄĒsingle, married, and heads of households.¬†

The first estate tax was enacted in 1797 to fund the U.S. Navy. It was repealed but reinstituted over the years, often in response to the need to finance wars. The modern estate tax as we know it was implemented in 1916. 

Other taxes as a corporate income tax were enacted slightly earlier in 1909. 

 

Wars are Expensive 

In 1913, the States ratified the 16th Amendment, instituting the federal income tax where the actual form and directions were a mere four pages…today the total an intimidating 106 pages.  Income tax rates ranged from 1% on income of $0 to $20,000 up to 7% on income over $500,000. 

However, to finance America’s participation in World War I, Congress passed the 1916 Revenue Act and then the War Revenue Act of 1917.  From 1916 to 1917 the tax rate jumped from 15% to a whooping 67%…then finally settling at 77% in 1918. 

Wars are Expensive!  So, after the war, the federal income tax rates took on the steam of the roaring 1920s dropping to 25% by 1931.  The gift tax came about in 1924.  Sales taxes were first enacted in West Virginia in 1921. Eleven other states followed suit in 1933.  

 

The Great Depression 

The Great Depression was a worldwide economic downturn that began in 1929 and lasted until about 1939.  It was the longest and most severe downturn experience by the Western world, causing fundamental changes to economic policy, theory, and institutions.  But by 1933, the American recovery was in full swing.  But Congress raised taxes again in 1932 during the Great Depression to 63% on top earners…potentially lengthening this recovery progress.  Federal excise taxes on gasoline were implemented in June 1932 under President Herbert Hoover as part of the Revenue Act of 1932.  FDR signed the Social Security Act in 1935. The government first collected Social Security taxes in January 1937.  Dividend taxes were enacted in 1936 but only lasted through 1939. 

 

WWII and Beyond 

As mentioned before, war is expensive.  In 1944, the top rate peaked at 94% on income over $200.000.  By the end of the war and through the 1970’s, the top federal income tax rate remained high, never dipping below 70%.  Investment dividend taxes reappeared in 1954 and have persisted ever since.  The alternative minimum tax (AMT), a type of federal income tax, was not enacted until 1978, as a way to ensure everyone paid their fair share. 

It was not until The Economic Recovery Tax Act of 1981 that the highest rate was reduced from 70% to 50% and indexed the brackets for inflation.  The Tax Reform Act of 1986 expanded the tax base and dropped the top rate to 28 percent for tax years beginning in 1988.  The idea was that the broader base contained fewer deductions but brought in the same revenue. Further, lawmakers claimed that they would never have to raise the 28 percent top rate…this promised lasted three years before it was broken.   

By 1991 the top rate jumped to 39.6%.  However, the Economic Growth and Tax Relief and Reconciliation Act of 2001 dropped the highest income tax rate to 35% from 2003 to 2010. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 maintained this rate through 2012. 

The American Taxpayer Relief Act of 2012 increased the highest income tax rate to 39.6%. The Patient Protection and Affordable Care Act added an additional 3.8 percent on to this making the maximum federal income tax rate 43.4%.   

Today, the highest federal tax rate is 40.8%.  In context of this article…what’s the big deal?  Seems like a historically low tax rate.  But the difference between today and the past is the wide range of things that ARE taxed.  Actually, it may be easier to list the things that aren’t taxed…like…uhm…air?  LINK  However you split the baby, understanding America’s history on tax will cause you to cry and lash out in a violent rage or you will find ways to cope and develop strategies to take advantage of the complexity.  Either way, certainty is usually a valuable thing these days…and since death is inevitable…inevitably taxes only get worse when Congress meets. 

Happy Tax Day! 

 

Invito Energy Partners

‚Äú‚Ķbut in this world, nothing can be said to be certain, except death and taxes‚ÄĚ. What Benjamin Franklin was suggesting regarding tax, is as old as civilization itself. Take a long gaze back into history, and inevitability staring back at you is the long imposing face of the tax man. From every war, to every ruler, to the birth of Jesus himself; looking at history through this lens may shape the way we think, and feel, about ourselves and the cultures, as we understand them today.

 

Historically, tax is power to rule and affect human behavior. Limit that power and the effects on that behavior have massive implications.

 

Take the window tax, introduced by King William III, in England during the 18th and 19thcenturies. It was designed to impose tax relative to prosperity; the more windows you had, the more prosperous you probably were.

These simple property taxes resulted in changes to the daily lives for millions of Britons. Working conditions, architecture, and physical and/or mental health standards radically changed while folks developed ways to avoid the governments long arm into their pockets.

 

The American revolution, at its core, was a revolt over the oppressive taxation of the people. ‚ÄúNo taxation without representation‚ÄĚ was the cry. Every conflict from Iraq to the Roman empire was made possible by various taxes in some form.

 

The modern world today enjoys some of the highest tax rates in history with the average American paying 35% in taxes (UK 45% and France an astounding 55%). As a result, navigating the U.S. tax code has turned into an Olympic gymnastics event. So, what are we to do? If history is any indication, we will do what humans have always done‚Ķconform for ‚Äúthe betterment of society‚ÄĚ or contort around and away from the long arm of the tax man.

 

– Invito Energy Partners