“The perfection of taxation consists in so plucking the goose as to procure the greatest amount of feathers with the least possible amount of squawking.” So said Jean-Baptiste Colbert, King Louis XIV’s finance minister in regard to 17th century tax policy.
As it stands, your family goose may be subjected to some additional plucking soon. It was “leaked” last week (in his 2020 campaign plan) that the Biden administration is planning to nearly double the federal capital gains tax rate on taxpayers earning more than $1 million from 20% to 39.6%. In states with high taxes, the combined blended rate could top 50%.
Are you and your directors about to start squawking? Or are you already hoarse? While we steer clear of politics here at Family Business Director, we do aim to inform business owners on the three key financial decisions family businesses face: dividend policy, capital structure, and capital allocation. Clearly a move of this magnitude could leave certain planning strategies less advantageous and could possibly affect key financial decisions. Below we briefly touch on the capital gains tax and provide some helpful reminders for family business owners.
What Is the Capital Gains Tax?
From the Tax Policy Center, a capital gain is realized when a capital asset is sold or exchanged at a price higher than its basis. Capital gains and losses are classified as long term if the asset was held for more than one year, and short term if held for a year or less. Under current law, short-term capital gains are taxed as ordinary income at rates up to 37%; long-term gains are taxed at lower rates, up to 20%. Taxpayers with modified adjusted gross income above certain amounts are subject to an additional tax of 3.8% on long- and short-term capital gains stemming from the Affordable Care Act.
Family shareholders face the prospect of capital gains taxes upon the sale of the business or other significant assets. This could be commercial property, stock holdings, or a business interest that has appreciated over time.
From a cursory reading of the financial press and the short-lived market dip, public equity markets appear to be buying gridlock and selling tax hikes. Barron’s writers, Goldman Sachs analysts, and financial twitter prognosticators all seem to point to either a more modest change (increase to 28%-30% rather than 39.6%) or some watered-down version of the proposal. We note that just two months ago eight Senators who caucus with the Democrats voted against a $15 minimum wage, giving further pause to the idea that 50 plus 1 is enough to ram anything through both chambers of congress. Family businesses would be mindful not to count their tax chickens before they hatch – or are even laid.
Do Take a Second Look
While we don’t want to talk out of both sides of our mouth, taking a look at some appreciated assets, especially if they are readily liquid, could take some tax risk off the table. Many of the family businesses we work with have considerable stock portfolios outside their main operating businesses. Consider having a second conversation with your financial advisor to see if you could take advantage in some large winners in the current environment. And for future planning, check with your advisors to see if you can spread events that trigger capital gains over multiple periods to avoid the $1 million income level. Like-kind exchanges and other tax-planning strategies may be worth a second read if the preferential tax treatment goes away.
Remember the Big Picture
As we have written about continuously in the blog, family business directors have longer-term objectives than meeting next quarter’s numbers. Family business directors plan with long-term family wealth and succession in mind. As we noted in dissecting the world’s largest family businesses, almost half of the 750 companies in the list have been in business for over 70 years. Over that same time, the capital gains rates have changed dozens of times, oscillating between high teens to just under 40% (albeit briefly in the mid-to-late 70s). What your family business means to you, whether it’s a growth engine or a source of lifestyle, likely won’t change dramatically as a result of your capital gains tax exposure. Remember, running your business and fostering long-term wealth creation is the ultimate goal of any family business director.
When thinking about your current business situation, the toughest time horizon to have is short term. Should we accelerate plans to sell so we can avoid a larger tax bill? Should we realize some gains in the family securities portfolio to avoid the possibility of an increase in long-term capital gains rates? We think long-term minded family business directors are in prime position to ride through the tax waves and steer their family ships safely on their long voyages. Give one of our family business professionals a call today to talk about balancing tax concerns with the long view on your family business.