Capital gain is the profit from selling a capital asset for more than the purchase price. Examples of capital assets include property, stocks, bonds, and equipment. The tax on that capital gain differs based on how long the asset was held. If the asset was held for more than one year before the sale, it is considered a long-term capital gain. Assets sold after less than a year of ownership are classified as short-term and taxed like ordinary income.
Prior to the Tax Cuts and Jobs Act (TCJA) in 2018, tax rates for long-term capital gains and income taxes were very similar. Now, there are unique tax brackets for long-term capital gains taxes that typically fluctuate from year to year. For example, in 2021, taxpayers filing single had a 0% tax rate on capital gains up to $40,400. In 2022, the same taxpayer will have a 0% rate on capital gains up to $41,675.
Early versions of the highly debated Build Back Better Act included an increase to the capital gains rate. That proposed increase has been removed, but since the bill has not been passed at the time of this writing, there is still the possibility that President Biden could successfully include a capital gains rate increase in later proposals. For 2022, the highest capital gains rate remains at 20% while the highest ordinary income rate is 37%. Although it depends on your income tax bracket, most people benefit from holding onto an asset for 12 months or longer before selling it to benefit from the lower capital gains tax rate.
However, some states have no income tax and therefore, do not have capital gains taxes. Other states offer credits, deductions, or exclusions for capital gains. Consult with a business appraiser and tax experts to determine what your state requires or allows for capital gains.
According to the IRS, “The sale of a business is not the sale of one asset.” When you sell a business, each asset is assessed differently and may be classified as a gain or loss. The structure of a business and your role in the business will impact how proceeds from the sale are taxed. In a partnership, the sale of a partner’s investment in the partnership is treated as a capital gain or loss for the owner, not the business.
In a corporation, shareholders have capital gains or losses when they sell shares, not necessarily when the business is sold. Other considerations such as liquidation of property may be treated as a sale or exchange for the corporation, not the owners. Because each asset in the business is treated separately, it is likely the sale will include a mix of capital gains, goodwill, and ordinary income tax. Selling a company is complicated and it is important to seek the advice of tax and legal advisors early in the process to maximize tax savings.
Before you consider selling your business, find the records relating to the purchase, maintenance, and improvement of all your assets. This includes your investments made when starting the business. Take inventory of any physical assets to be included in the sale. Find an appraiser to get a valuation of your business and meet with a tax consultant to determine what classification each of your assets falls into so you can prepare for the sale. Consider how asset classification will impact the sale of your business. In many cases, tax classifications benefit one party, but not the other in a business sale, so there must be careful negotiations and clear documentation.
If you’re looking to sell your business in the near future to take advantage of the low capital gains, Oak Street Funding can help. Check out our exchange site where you can list your agency or practice for free. This complimentary service will get your business noticed by buyers all over the United States who are looking for a business just like yours. Contact us today to get your business listed!