This year presents the last likely opportunity to take advantage of lower capital gains for those IT business owners contemplating a sale today or anytime in the next several years. First, there is no doubt that capital gains will be going up, perhaps doubling. While some are predicting the jump could happen in 2022, others are saying it could kick in this year. Second, today’s strong seller market means higher offers. Both situations will enable accelerated sales which close this year to result in a significantly better post-transaction tax outcome than waiting until next year or later. Even if you are not planning to sell your IT business now, modeling the now vs. later scenarios will help you better understand the full implications of that decision.
When the owner of an IT business sells the company, the majority of proceeds are taxed as long-term capital gains at the current federal tax rate – 20 percent. The Biden administration has already proposed under the “American Families Act” increasing the federal long-term capital gains rate to as high as 39.6 percent, which would greatly slash sale proceeds for sellers. Take the example of an IT business owner who sells the venture for $10 million before the end of 2021. Under the current capital gains rate, the federal tax bill for that sale would total $2 million. Next year, that same sale would likely carry a tax burden of $3.96 million.
Another consideration, regardless of any federal tax increase, is state capital-gains taxes. Keep in mind, the overall tax burden will vary based on your state. For example, a Georgia-based IT services company owner will likely see less of an overall increase than that of their peers operating IT businesses in highly taxed states such as California, New Jersey, New York and Oregon. Combined capital gains tax rates for those states will likely top 50%!
Without a crystal ball, no one can know what the final increase in capital gains and its full effect on the sale of an IT business. But one thing is clear: Sellers cannot expect buyers to compensate them for their higher tax bills. Keep this in mind as you look into the financial and tax liabilities associated with selling now as opposed to selling after these tax changes take effect. Once again, and it bears repeating, 2021 presents the last likely opportunity to take advantage of lower capital gains for those IT business owners contemplating a sale today or anytime in the next several years.