There were 66 million babies born between 1945 and 1964. The era was known as the “Baby Boom,” and the “Boomers” are reaching retirement age. In fact, the oldest are now turning 66 and the youngest are in their mid-forties. Many of these people have worked hard throughout their lives and have built businesses from the ground up. A considerable amount of wealth has been created, and those owners are now looking to retire or move on from their businesses.
Currently in 2010, favorable tax rates allow business owners to pay fewer taxes on the sale of the business as opposed to waiting until 2011. During the Bush administration, both capital gains and dividend tax rates were decreased to 15 percent. Those tax cuts are set to expire on December 31, 2010. The rates coming in 2011 will be 20 percent for capital gains and the ordinary tax rate for dividends can be as high as 39.6 percent.
The capital gains rates are currently 0 percent and 15 percent. Historically, the capital gains rates have been as high as 20 percent. This means that capital gains will be taxed at 0 percent if the combined adjusted gross income of the selling taxpayer (including capital gains) is at or below the two lowest tax brackets. The amount of capital gains earned by a taxpayer that is at or over the 25 percent bracket is currently taxed at 15 percent. These new rates produce much more favorable tax consequences than in past years.
For example, if a company is sold and capital gains are determined to be $1,000,000 in this tax year, the seller of the company would pay $150,000 in capital gains taxes as opposed to $200,000 in a future year. The result is a tax savings of $50,000, just because the sale happened this year as opposed to next year.
Unless Congress acts to the contrary, the capital gains tax will go up in the next year. If you fail to take gains this year, they will be taxed harsher next year.
If you own stock in a C Corporation you most assuredly have had, at one time or another, dividends distributed to you. Currently, and for the good part of the past decade, dividends are taxed at 15 percent. No matter what income level you were at, dividends received a preferential rate, making the C Corporation a good buy and a good business entity for tax purposes. The laws giving rise to the preferential treatment are coming to an end on December 31, 2010, as well. On January 1, 2011, dividends will be taxed at the ordinary income tax rate of the taxpayer.
The significance is that this year is an opportune time to cash in corporate retained earnings. This is sometimes done during business sales to cash out the retained earnings, lessening the tax burden. If this is done in 2010, the tax rate will be 15 percent. Next year, dividends are taxed at a maximum rate of 39.6 percent, as the ordinary income tax rate regains its old position as well.
To illustrate the point, a taxpayer in 2010 who cashes out retained earnings of $1,000,000 will pay $150,000 in taxes. Next year, the same taxpayer could pay up to $396,000, well over double the 2010 tax consequence. This is a difference of $246,000 for the same dividends distributed to the same person.
With the imminent increase in the capital gains tax and the dividend tax rates, owners of closely-held businesses are well advised to sell their businesses this year as opposed to next in order to take advantage of the lower tax rates. A business sale this year resulting in a $3,000,000 gain is a mere $450,000 in tax. Next year, a $3,000,000 gain could result in $600,000 due. The difference in taxes between the two years is considerable.
|Meet the Author
Bart A. Basi is senior adviser of The Center for Financial, Legal and Tax Planning, located in Marion, Illinois, and on the Web at www.taxplanning.com.