As the American economy attempts to rebound after an unprecedented 2020, potential tax changes are on the horizon that could impact Pacific Northwest business owners starting next year. With the passage of the American Rescue Plan in March, the White House is turning towards further measures to stimulate the economy.

Along with a rebounding M&A market, (see “2H 2020 Chinook Report” for more information on current M&A trends) and potential tax changes, this is an ideal time for Pacific Northwest business owners to evaluate their transition plan.

Proposed Federal Tax Changes

In April, the White House released a plan to fund infrastructure projects by increasing the following tax rates:

1.     Doubling the top capital gains tax rate to 39.6%. Currently, the rate is 20% for individuals with $1 million or more in adjusted gross income.

2.     Raising the top ordinary income tax rate to 39.6%. Currently, the rate is 37%.

3.     Boosting the corporate income tax rate to 28%. Currently, the rate is 21%.

4.     Increasing the estate tax rate to 45%. Currently, the rate is 40%.

In reality, the tax rates could potentially be lower through legislative compromise.

Based on these proposed tax rates, if Pacific Northwest owners decided to sell their businesses, they would pay almost $4 million in taxes on $10 million in gross proceeds.

While the new administration has a pathway to enact legislation with control of both the House and Senate, it is unlikely but not impossible tax changes could take effect during the 2021 tax year.

Proposed Washington State Tax Changes

A modification in federal tax rates is not the only event for business owners to carefully monitor. Washington State legislators approved Senate Bill 5096 in late April. The bill proposed a 7% state capital gains tax on the sale or exchange of assets over $250,000 in value.

The tax will take effect on January 1, 2022. Capital gains in 2021 are not subject to the tax. Business owners are not taxed if they regularly ran the company for five of the previous 10 years before selling, owned the business for a minimum of five years, and earned $10 million or less in revenue a year before the sale.

Qualified family-owned small businesses are allowed a deduction on this tax bill. To qualify, a business owner must hold a qualifying interest for at least eight years, a family member actively works in the business for at least five years, the business has no more than 50 full-time employees for at least 12 months before the sale, and the business generated no more than $6 million in annual revenue.

On $10 million in gross proceeds from the sale of the business, business owners would have an additional $680,000 added to their tax bill.

As of publishing, the bill passed the Washington State Senate and the House of Representatives. Washington’s governor signed the bill into law in May 2021. The bill is facing multiple challenges in court because the Washington Supreme Court has ruled income taxes unconstitutional in past rulings.

With multiple tax initiatives potentially implemented that would add millions to a tax bill for fiscal year 2022, owners contemplating the sale of their business should plan to ensure they are not impacted by potential new legislation (see the article “It Takes a Team to Sell a Business” for more information on preparing for a transaction).

 

Sample Tax Bill Calculator

The following scenarios illustrate the potential tax increases from federal tax rate changes. Pacific Northwest business owners could face 20%+ additional taxes that would decrease their after-tax proceeds.

 

Takeaways

1.     Proposed federal tax legislation could significantly decrease the after-tax proceeds business owners receive after they sell their businesses. While most experts predict legislation would take effect in 2022, it leaves a limited window for transactions to close under current tax rates.

2.     Washington State legislators are actively reviewing capital gains legislation that could affect tax bills after sale of businesses.

3.     The Chinook team actively tracks tax developments as they pertain to mergers & acquisitions and will provide regular updates. To learn more, contact us.

 

*Chinook Capital Advisors does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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