Taking Advantage Of The Lower Capital Gain Rate
Never known for promoting simplification in the Tax Code, Congress added a new twist to the capital gain rate that you may have forgotten.
Beginning in January, the long-term capital gain tax rate was reduced from 20% to 18% for assets held for at least 5 years. Taxpayers in the 15% tax bracket saw their rate reduced from 10% to 8%.
A 2% rate reduction. Not huge, but sounds pretty good, right? Hold on. To qualify for the 18% rate, the asset cannot be acquired before January 1, 2001. So, while this change will help you on assets you acquire in 2001, you will still pay a 20% rate on long-term capital gains from assets you owned as of December 31, 2000. Unless...
Working With The Law
Under the new provision, you can elect to treat an asset held on January 1, 2001 as if it were sold at fair market value and reacquired on that date. This allows you to start the 5-year holding period over again on that asset.
The clincher is...any income tax due on the gain from this deemed sale must be paid.
If you have to pay the tax on the gain, why would you want to do this? Maybe your built-in gain in the asset on January 1st is minimal. Or, perhaps you have excess net operating losses, capital losses, or charitable contribution carryforwards that you want to use up.
Making that election would be a good idea if you have capital assets with a built-in loss on January 1st.
While you can't recognize the loss, you would be able to start your holding period over again. Then, if you hold the asset for 5 more years, you'll get the benefit of the lower rate.
Lower Tax Bracket Benefits Now
Note that if the taxpayer is in the 15% tax bracket, the holding period does not need to begin after December 31, 2000 to enjoy the benefit of the 8% rate. Therefore, while you may not get any immediate benefit from this provision, maybe your teenagers will.
The new 18% capital gain rate arrived without much fanfare for most Americans. But, there are certain situations where planning around the new rate will be beneficial.
If you have questions about how this new rate may affect your tax picture, call us.
Taxes Play A Big Part In Overall Price
Buying or selling a business can be both exciting and traumatic. In all the excitement it may be hard to concentrate on something as dry, and seemingly mundane, as taxes.
But, taxes affect the real price of the business. And, being unprepared can cause a serious blow to your economic expectations.
Malcolm Forbes once said, "People overvalue what they are not and undervalue what they are." That saying holds true for setting the value of your business. Setting the price (and getting a good one) is often the most important aspect of the transaction.
Know The Real Price
The question is: Do you know the real price of your business? Components that make up the real price include:
 | The type and quality of the consideration. |
| The timing of the payments. |
| The tax effect of the transaction. |
These components overlap, with the type and quality of the consideration and the timing of payments having a huge impact on the overall tax effect of the transaction.
To determine the real price of your business, you will need to compare the tax effect of various reporting alternatives and a range of prices. Intangible assets, such as goodwill and intellectual property rights, both inside the business and outside the business (if any) will need to be identified. You should also consider other, interrelated agreements, such as employment, consulting or noncompete.
Don't start negotiating until you know what you really have and what your possible options are.
Taxable Or Not?
The majority of businesses are sold in taxable transactions. Non-taxable transactions include mergers and situations where the seller takes as consideration buyer stock or qualifying property in an exchange.
Although the general tax-planning rule is to avoid or postpone tax, there are some advantages of a taxable sale:
| When the seller gets cash, concerns about the quality of buyer stock or the limitations inherent in selling buyer stock are nonexistent. |
| The buyer doesn't have to contend with the seller as a shareholder and the buyer can get a stepped-up basis in the assets. |
| The parties also don't have to worry about the technical requirements of a tax-free or tax-deferred transaction. |
A taxable sale can be structured as either an asset sale or a stock sale. In general, the seller wants a stock sale and the buyer wants an asset sale. See below for a comparison of these two alternatives.
Asset vs. Stock Sale
Asset Sale
Seller:
| Potential double taxation resulting in less net, after-tax proceeds. |
| Potential ordinary income, recapture, or higher tax rates on some assets. |
| Installment sale treatment may not be available. |
| Business can generally sell without minority shareholder consent. |
Buyer:
| Can avoid (not acquire) unwanted assets and liabilities. |
| Assets have basis equal to fair market value paid. |
Stock Sale
Seller:
| One level of taxation. |
| Capital gain treatment. |
| Installment sale treatment generally available. |
| Minority shareholders may not want to sell. |
Buyer:
| Takes over all assets and liabilities in corporation at purchase. |
| Assumes exposure to potential liabilities. |
| May have minority shareholder issues. |
| Assets have carryover basis (tax basis doesn't change). |
Timing Of Payments
In the past, whether the business sold assets or the shareholders sold stock, the transaction was often structured as an installment sale. This method helped match the recognition of gain to when cash was actually received.
However, this logical, tax-advantaged sale treatment is no longer available to many taxpayers.
A law enacted in 1999 prohibits taxpayers that use the accrual method of accounting from using the installment method for sales after December 16, 1999.
Since most businesses are accrual basis, this pretty much eliminates installment sale treatment on the sale of assets and throws a huge monkey wrench in planning the sale of a business.
Small, closely held businesses are particularly hard hit by this law change. The Small Business Administration says that 1.3 million of these businesses are sold each year. The repeal of installment sale treatment is expected to effectively lower the price of a closely held business by as much as 10%.
In response to widespread criticism over the law, the IRS now allows qualifying taxpayers with average annual gross receipts of $1 million or less to use the installment method of accounting. This limited relief also has its critics. Most say the $1 million limit is too low to help many small businesses. And, having to change the company's accounting method to cash basis has its own limitations and potential adverse effects.
Repeal Cuts Deep
The repeal of the installment sale method affects other practical aspects of business sales. For example, sales are often ideally structured as installment sales because the buyer doesn't have enough cash on hand. But, an installment sale without the corresponding tax treatment leaves the seller with a tax bill and no money to pay it.
Installment sales were also useful since many small businesses are sold with an "earn-out" provision, where the buyer pays a contingent amount over a number of years, based on the business's performance. After the repeal, sellers now have to forecast the value of the note and deal with numerous problems involved with such an estimation.
Without the option of installment sale treatment for the sale of assets, the sale decision swings even more in favor of a stock sale where the installment method would still be available (assuming the seller is an individual).
Regardless of the method chosen, you need to determine what you believe to be the real price of your business.
This article has just scratched the surface of the tax issues involved in buying or selling a business. Before you start negotiations, call us. We can help you draft and review the entire contract, to ensure you receive the best tax treatment.
How To Take Distributions The Right Way
Despite the current slump in the US stock market, most baby boomers have watched with glee as their IRAs blossomed into significant assets. With many boomers ready to tap into these assets, it's a good time to review the distribution rules.
The Basics
Generally, you may begin taking distributions from your IRAs at age 59 1/2. If you have a traditional IRA, the earnings on that account will be taxed at your marginal tax rate when withdrawn. To the extent that you have made nondeductible contributions, a pro-rata portion of your distributions will be tax-free.
One advantage of a Roth IRA over a traditional IRA is that you may withdraw your contributions from a Roth IRA at any time - even before age 59 1/2. You may also withdraw earnings tax-free before age 59 1/2 if you have had the account for 5 years and the distribution is:
| Made to a beneficiary or your estate after death. |
| Because of a disability, or |
| Used for first-time homebuyer expenses of up to $10,000. |
The main advantage of Roth IRA is that once you turn 59 1/2, you may withdraw your earnings tax-free (assuming the account has been open for 5 years). However, contributions to a Roth IRA are never deductible, unlike most contributions to a traditional IRA.
Early distributions (or distributions from a Roth that are otherwise disqualified) are generally taxed and penalized unless the distribution is used to pay for:
| Medical insurance premiums if unemployed. |
| Higher education expenses for yourself, your spouse, child or grandchild, or |
| First-time homebuyer expenses up to $10,000. |
The Requirements
To keep taxpayers from accumulating large retirement plans solely to pass them on to their heirs, traditional IRAs are subject to minimum distribution requirements. Roth IRAs aren't subject to these requirements during a taxpayer's lifetime.
You must begin taking minimum distributions from your IRA by April 1st of the year after you turn 70 1/2. You then must take a minimum distribution by December 31st of that year and by the end of each subsequent year. You'll face a 50% excise tax if you don't take these distributions.
Of course, you may take more than the required minimum distribution any time. But, if you don't need the funds for living expenses, it's wise to delay distributions as long as possible to maximize the tax deferral of the earnings inside the IRA.
If you have multiple IRAs and they all have the same beneficiary, their values must be aggregated to determine the minimum distribution amount. The actual distribution can come from just one or any combination of accounts.
The minimum distribution is determined by dividing the value of the IRAs at the end of the previous year over the expected life expectancy of either the account owner or the joint life expectancy of the owner and designated beneficiary. Using a joint life expectancy will reduce the required minimum distribution. The life expectancy is determined from IRS tables based on the ages of the owner and beneficiary.
If you use a joint life expectancy, you need to name the beneficiary before the beginning of your minimum distributions. While you can change beneficiaries later, the amount of the minimum distribution cannot be less than the original calculation. A maximum age difference of 10 years between you and the beneficiary is used for the life expectancy calculation (unless the beneficiary is your spouse).
As you can see, there are many factors to consider before you start taking distributions from your IRAs. Give us a call to review your options.
If you have any questions or comments contact us at Shonsey & Associates
This website designed and maintained by Dennis D. Fierstein
©Copyright 1998 Shonsey, Almquist, Kucera, Maltzahn & Galloway, P.C.
This information is not
intended for use without professional advise.