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Is It Time to Worry About Capital Gains Tax Rates?

2020 finally is in the rear-view mirror. As we have reported throughout the year, the M&A market for insurance brokers remained at peak, pre-pandemic levels despite all of the public health, political, social, and economic dislocations. S&P reported that the number of insurance brokerage transactions closed in 2020 slightly exceeded those in 2019. Sica | Fletcher closed 125 transactions in 2020 (our best year ever, and again, leading the league tables) in comparison with 92 in 2019 and 79 in 2018. And as of today, the most active acquirers continue to be highly interested in acquisitions. We typically see at least the same peak multiples as before the pandemic struck and the same number of parties interested in the companies we are bringing to market, along with private equity firms continuing to drive transaction pace and value.

However, there appear to be storm clouds gathering on the horizon. If you are considering selling your agency over the next few years, there is a bit more urgency now.

It appears increasingly likely that capital gains tax rates will rise, potentially substantially, later this year, or in 2022. If you wait, you run the risk of paying a lot more in taxes when you sell.

The New Administration Plans to Spend a Huge Amount of Money

President Biden’s economic plan envisions substantial expenditures, both in the short term for COVID relief and over the course of the next decade to achieve his platform of economic recovery.

In the middle of January, the Biden administration unveiled the details of its $1.9 trillion coronavirus rescue package, called the American Rescue Plan. The objective of this plan is to support households and businesses through the end of the pandemic. Among its many items, this rescue plan:

  • Envisions direct payments to most Americans of an additional $1,400

  • Increases the federal minimum wage to $15 per hour

  • Increases federal per week unemployment benefits and extends them through September

  • Expands eviction and foreclosure moratoriums through September

  • Provides funds for COVID-19 testing and vaccination programs

  • Provides substantial aid to state and local governments, schools and institutions of higher learning

Furthermore, the Biden Administration seeks to roll out its major long term economic recovery plan, the “Jobs and Economic Recovery Plan for Working Families,” over the next few months. The Penn Wharton Budget Model, a nonpartisan research-based initiative housed at The Wharton School, estimated that spending on this plan would be approximately $5.4 trillion over the next decade. Targeted areas include public healthcare, universal pre-K, schools serving low-income students, two years of guaranteed debt-free college, tuition-free public college for lower-income families, investments in water and transit infrastructure, and clean energy R&D.

Taxes Must Increase to Pay for All or Part of These Expenditures

The proposals outlined above will require an enormous amount of capital expenditures. These will have to be paid for, either through increased government revenue or through increased deficits. The President outlined his tax plan in his platform. According to The Penn Wharton Budget Model, this tax plan would raise approximately $3.375 trillion in additional taxes over 10 years and approximately 80% of this amount will be paid for by the top 1% of households by income. The plan is explicitly designed not to raise taxes directly on those with adjusted gross incomes of $400,000 or less.

The Impact on Capital Gains Rates

Incorporated in President Biden’s tax plan is a substantial increase in capital gains tax rates. President Biden’s policy platform explicitly states that he will propose that the capital gains tax rate be increased to the ordinary income rate for those making over $1 million. Additionally, he is proposing to increase the top income tax rate from 37% to 39.6%. Overall, this would represent over a 19.6% increase from the current long term capital gains tax rate of 20%.

To illustrate the point even more clearly, here will be the additional capital gains tax payable at different levels of gain, assuming this plan is enacted into law:

The bottom line is if you sell your business after this tax increase goes into effect, you will pay substantially more in taxes and retain far less of the transaction proceeds.

The Ongoing Questions

Let us be clear - there is a lot we currently do not know. We do not know if and under what terms the COVID-19 rescue package and long-term economic recovery plan will be passed. We do not know if and when the tax plan will successfully wind its way through the House and Senate. We do not know whether the tax plan will be passed later this year or in 2022.

Furthermore, we do not know the details of this tax plan. What will be the definition of those making over $1 million for the purpose of triggering the much higher ordinary income rate on capital gains? If this definition includes the capital gains from the sale of a business, the higher rate will be applicable to every seller of an agency. Will the tax increase be retroactive (as some changes in tax law have been in the past), effective as of the passage of the legislation or applicable upon the next tax year?

There is, however, one thing we can say with certainty. The likelihood is that taxes will go up at some point in the next year or two to pay for at least a part of this enormous proposed increase in spending, and this tax increase is very likely to impact the capital gains tax rate.

In Conclusion

Given the analysis above, if you believe that you might have an interest in exploring your strategic options for the business over the next few years, time may be increasingly of the essence. We are here if you would like to have a discussion about your strategic options - please contact us or call us directly at 516.967.1958. We are here to help and would appreciate the opportunity to develop a dialogue and work as your strategic advisor to help you reposition your business for further growth and success.


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