This isn’t a political post and it isn’t just about President Obama’s re-election. It’s also about the Republicans retaining control of the House and the Democrats retaining control of the Senate. The net result is more of the same, so what does that mean for the business owner?
Now Is The Time To Sell
Between now and December 31st is prime time to sell your business or an interest in your business. Why? 8.8%.
As things currently stand, the healthcare law’s 3.8% Medicare surtax on dividends, interest, and net capital gains goes into effect next year. In addition, the top capital gains rate is set to increase from 15% to 20%. This means a net loss to you of 8.8% in income taxes by selling next year instead of this year.
This doesn’t leave much time to realize those savings if you haven’t already started the process.
Now is this set in stone? No. The likely scenario isn’t as stark as this. The healthcare surtax isn’t going anywhere but my guess is that the lame duck Congress will kick the 5% capital gains increase down the road along with the automatic spending cuts. So come January 1st, you only lose the 3.8% surtax.
However, at some point around mid-year or possibly at the end of the year, that 5% will capital gains tax increase will come into effect. There is just not enough interest to prevent that from happening given the current fiscal situation.
Finding a buyer often isn’t a quick or easy process. My advice: if you are looking at selling your business or even a small interest in a company, now is the time to start. The quicker you close the deal, the less of a hit you will take.
The S-Corp May Not Be All You Thought It Was
One of the biggest attractions, especially for toilers or people who work for their business in addition to owning it, is the S-Corp’s ability to limit the self-employment tax impact. As long as the toiler receives a reasonable salary, the S-Corp can distribute the excess profit via dividends without incurring self-employment taxes.
At some point there will be a deal between Democrats and Republicans to resolve the “fiscal cliff” whether it occurs in the next couple of months or sometime next year. The resolution will likely involve a compromise that raises taxes and cuts spending. This S-Corp “loophole” is a prime target for both sides for a few of reasons. The subject has been on the radar for years so it is ripe. It only affects companies that qualify for S-status which means they tend to be small private companies, not large public companies. It’s also inconsistent with the partnership treatment for pass through LLC interests although the intent of that section is to allow partnership treatment in a corporate structure.
My advice: limiting self-employment taxes should be a very small consideration in evaluating S-Corp’s during the choice of entity analysis for new ventures. It’s easy to get in but hard to get out. Legally, S-corps are easy to convert but the tax impact can be very complex and require re-characterization of transactions over years. On the other hand, electing and converting to S-corp status for an existing company is a relatively simple process. Wait for a resolution to the “fiscal cliff” issues before making that decision or consider an alternative structure.