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How Biden's Proposed Tax Plan Could Impact Your Company's Exit Strategy

Tax implications could be drastically different 18-24 months from now and M&A markets are preparing to react to increased liquidity events in 2021 and beyond. The implementation of the proposed Biden Plan would have negative tax consequences which would cause a significant impact on net proceeds from any potential M&A transaction. Taxes on capital gains could rise to 40 percent for proceeds of a business sale over $1M. Individuals can expect a reversal of at least half of Trump’s signature tax cuts to pay for the plan.

For business owners generating over $1M in the sale of the business, expect to have earnings (“capital gains”) taxed as ordinary income under the Biden plan. Today, capital gains are taxed as income. A capital gain is a profit from the sale of a capital asset, such as a stock or home, from the time that asset is acquired until the time it is sold. Taxpayers pay the difference on the purchase price of the asset (“basis”) less the sales price.

Three Major Components Of The Plan

The plan has three major components: raising the corporate income tax rate to 28 percent, revoking the TCJA’s income tax cuts for taxpayers with taxable income above $400,000, and imposing a “donut hole” payroll tax on earnings in excess of $400,000.

The Biden Plan has considerable impact to business owners; careful consideration to the timing of an exit and liquidity strategy needs to be at the mind’s forefront as the 2020 election quickly approaches. If endorsed, the plan impacts owners directly through the implementation of new tax obligations or the elimination of tax benefits. This includes a 19.6 percent increase on the tax rate of material long-term capital gains for those with adjusted gross income (AGI) exceeding $1M, and a 7 percent increase in the overall corporate income tax rate as noted in the table below.

Example: Assume a $2.0M EBITDA business receives a valuation multiple of 10x for a total transaction value (taxable gain) of $20.0M. Under the Biden Plan, the seller would lose $3.92M in the sale. To receive the same net proceeds, a multiple of 13.2x would need to be secured.

Independent of the 2020 election, taxes are being reevaluated at the state level. This includes increased tax burden on transaction proceeds. The adoption of the proposed graduated income tax rates proposed in states such as Colorado, Illinois, and Michigan would result in a higher state tax burden for high earners. California has already adopted this measure and has a 13.3 percent top marginal tax rate for individuals with income above $1.0M.

 

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What If I Want To Transfer My Wealth?

The step-up in basis for inherited capital assets may cease under the plan. This elimination translates to more taxes on wealth passed to heirs and ending favorable tax rates on capital gains for anyone making over $1M.

How Are My Stocks Affected?

The 2017 tax reform law dropped the corporate income rate to current 21 percent level. The proposed plan increases the corporate tax rate from 21 to 28 percent.

For people that earn $300,000 a year, you more than likely own shares in publicly traded companies. Under the plan publicly traded companies will be paying higher taxes which means less cash available for dividends to stockholders. Biden is suggesting a 15 percent minimum tax on large corporations. Goldman Sachs has projected that Biden’s tax plan would lead it to reduce its 2021 earnings estimate by 12 percent.

The tax rate on Global Intangible Low Tax Income (GILTI) earned by foreign subsidiaries of US firms will double from 10.5 percent to 21 percent.

How Is The Overall Economy Affected?

Experts suggest this plan would shrink the size of the economy by 1.51 percent due to higher marginal tax rates on capital and labor. A decrease of 3.23 percent in capital stock and reduction of 0.98 percent to the overall wage rate would lead to 585,000 fewer full-time equivalent jobs according to the Tax Foundation’s General Equilibrium Model.

Over the course of the next 12 to 24 months sellers and buyers alike will be keeping a pulse on the results of the 2020 presidential election and the possibility of a significant tax overhaul. It is important to note the reality of the Biden Plan coming to fruition can be driven by not just a Biden election; other drivers can include Democrat control over the U.S. House of Representatives or a change in control in the U.S. Senate from Republican to Democrat.

With the 2020 election on the horizon, it is crucial that business owners contemplate the potential tax consequences and consider crafting an exit strategy now to be ahead of the tax changes.

The recipient should consult their own tax, legal, and accounting advisors before engaging in any transaction. This document 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.

Sources: Tax Foundation, Kipingler, Houlihan Lokey and Yahoo Finance

 

Author
Emily Cogley
Director
Benchmark International

T: +1 813 898 2350
E: Cogley@BenchmarkIntl.com

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