Back in the spring, we published a news flash describing the potential tax increases that the Biden Administration had proposed in order to fund its economic and social platform. The most important provisions relating to the sale of a business included proposals to (i) increase the top capital gains tax rate from 20% to ordinary income tax rates for those earning over
$1 million and (ii) to increase the highest personal income tax rate from 37% to 39.6%. The result would have been a whopping increase in the capital gains tax rate from 20% to 39.6%.
You will notice that we had not published another news flash until now. The reason was simply that it was unclear whether the President could muster enough support among his own party to pass a reconciliation bill approving any form of tax increase and what that tax increase could look like.
On September 13th, the House Ways and Means Committee released its tax proposals to fund the President’s $3.5 trillion social and economic program. We believe this draft provides some guidance for our readers about the possible contours of the final tax legislation; however, with some important caveats:
The House Ways and Means Committee proposal is simply a proposal, and is far from passage into law.
The proposed legislation must be passed in both the Senate and the House through the reconciliation process. The terms of the reconciliation process affect the Senate the most, since it reduces the required vote from a supermajority to a majority (51 votes or 50 plus the vote of the Vice President).
There are 50 Democrat Senators, so a reconciliation bill would require the vote of every single Democratic Senator, plus the vote of the Vice President; no Republican Senator will vote for these tax increases.
This is where things become complicated, since a number of Senators have announced their opposition to different parts of this legislation. In the horse trading to come, the legislation will change to accommodate realpolitik, and no one can predict with certainty what the end result will look like.
Having said that, the House Ways and Means Committee proposal is important because it shows directionally where things might be headed, and they appear heading in a quite different direction than the President’s original proposal (in a way that is more positive from the perspective of those potentially selling a business).
Implications for Sellers
Here are the provisions of the draft legislation as they affect the potential sellers of insurance brokerages and other businesses:
Capital Gains Rates – The top capital gains tax rate would increase to 25% from 20%. This is a far cry from the 39.6% top capital gains tax rate proposed by the Biden Administration. The draft legislation currently provides that 2021 is treated as a transition year, with transactions either completed on or before September 13, 2021 or subject to a written binding contract on or before that date subject to the 20% capital gains rate. All other transactions would be subject to the higher 25% rate.
Income Tax Rate – The top marginal individual income tax rate would increase to 39.6% from 37% for married individuals filing jointly with taxable income over $450,000 and for individuals with taxable income over $400,000. Unlike the President’s proposal, this has no impact on capital gains rates; however, the proposal would include a surcharge of 3% for taxpayers with modified adjusted gross income in excess of $5 million. This surcharge is effective as of January 1, 2022. It appears that this surcharge would apply in the sale of a business, but we will know more as the legislation progresses.
Changes to Net Income Investment Tax (NIIT) – The proposal indicates that the NIIT would be expanded “to cover net investment income derived in the ordinary course of a trade or business for taxpayers with greater than $400,000 in taxable income (single filer) or $500,000 (joint filer).” The NIIT is a 3.8% tax which was imposed, as the IRS described it, on “certain net investment income of individuals, estates and trusts,” effective January 1, 2013. The IRS indicated that this tax applied to “passive activities” of the taxpayer. You should check with your tax advisor to determine if this tax in its current form or potentially expanded form would apply in the sale of a business.
The bottom line is that the proposed legislation is generally much better news for sellers of businesses than President Biden’s proposals earlier this year. The top capital gains rate would be 25% (absent application of the 3.8% NIIT and 3% surcharge described above) instead of 39.6% (absent application of the 3.8% NIIT) in President Biden’s proposals. As we emphasized earlier in this article, the House Ways and Means Committee proposals are simply in draft form and will likely change if enacted at all. We will have more to say about the potential implications of the tax changes for insurance brokerage M&A in 2022 in an upcoming blog, so stay tuned.
We at Sica | Fletcher are here if you would like to have a discussion about your strategic options – please email or call us: