You can be on Entrepreneur’s cover!

Selling a Business? A Delay Could Cost You The impending capital gains tax rate hike offers a compelling reason to sell this year.

By Domenic Rinaldi

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

Thinking of selling your business? Uncle Sam is offering a big incentive to act fast. As in, by the end of this year. The capital gains tax rate is set to jump from 15 to 20 percent on January 1, 2011. Surprisingly, many owners are unaware of these potential tax increases, and just as many don't know how it could affect them.

Upon the transfer of a business, the owner is faced with a tax bill based on the consideration received. The tax rates applied to the proceeds depend on how the purchase price is allocated amongst a variety of asset classes. The two most common tax rates are ordinary income and long-term capital gains. And with the top ordinary income rates at least double long-term capital gains, sellers are particularly interested in having a majority of the proceeds treated as the latter. In the sale of a business, the portion of the purchase price allocated between these tax rates is driven by what the parties can negotiate, as well as the tax code.

Currently, the largest source of Treasury revenues comes from individual income and employment taxes. Our mounting federal deficit all but assures that increases to the long-term capital gains tax will happen. In fact, most accountants and wealth mangers have been advising their clients to consider accelerating any tax liabilities, as we may never see today's tax rates again.

"[Another] compelling reason to consider selling a business this year, assuming one is otherwise motivated, is the likelihood that not only are capital gains rising, but ordinary income tax rates will likely be rising in the future," states Jeff Arnol, CPA and managing partner of Illinois accounting firm Kessler Orleans and Silver.

If an owner has considered selling their business today, the following analysis illustrates to what extent they would need to increase their bottom line to stay even. This illustration is meant as a guide, and you should consult with your tax advisor to better understand how these tax increases impact your personal situation.

Assuming you have a business that is sold and generates a capital gain of $2 million, the federal capital gains tax would increase from $300,000 (15 percent of $2 million) to $400,000 (20 percent of $2 million) if the sale were completed in 2011. This is an increase of $100,000 and does not include any additional federal or state income taxes. Keep in mind that income taxes are expected to increase, and if they do, this will take an even larger chunk of your sale proceeds. When considering all the proposed tax increases (capital gains, federal and state income), the net effect on business sale proceeds will likely decrease between 11 percent and 15 percent.

To offset the effect of these tax increases, a business owner would need to grow their bottom line by a considerable amount. Arnol explains another way to mitigate the tax increases: "If the current rate structure holds for the rest of 2010, perhaps it's time to pay some taxes and convert assets from illiquid to liquid ones and move on."

So the question becomes, do you consider a sale in 2010 or resolve to grow the business beyond its current value? It's a critical decision business owners shouldn't take lightly.

Domenic Rinaldi is president and managing partner of Chicagoland Sunbelt, a Chicago-based business brokerage firm that focuses on helping people buy, grow and sell businesses. Rinaldi is a Certified Business Intermediary from the International Business Brokers Association and brings more than 24 years of experience to the business brokerage arena.

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Side Hustle

This Dad Started a Side Hustle to Save for His Daughter's College Fund — Then It Earned $1 Million and Caught Apple's Attention

In 2015, Greg Kerr, now owner of Alchemy Merch, was working as musician when he noticed a lucrative opportunity.

Business News

I Designed My Dream Home For Free With an AI Architect — Here's How It Works

The AI architect, Vitruvius, created three designs in minutes, complete with floor plans and pictures of the inside and outside of the house.

Business Solutions

Handle In-House Projects More Efficiently with MS Project Pro — Just $24 Through April 16

It's designed to help teams stay on task with features like management templates, timesheets, generators, and more.

Business News

This Fan-Favorite Masters 2024 Item Is Still $1.50 as Tournament Menu Appears Unscathed by Inflation

The pimento cheese sandwich is a tradition almost as big as the tournament itself.

Business News

Here's One Thing Americans Would Take a Pay Cut For — Besides Remote Work

An Empower survey found a high percentage of respondents would take a pay cut for better retirement benefits and remote work options.

Business Ideas

63 Small Business Ideas to Start in 2024

We put together a list of the best, most profitable small business ideas for entrepreneurs to pursue in 2024.