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INNOVATION
& DESIGN Home Page Architecture Brand Equity Auto Design Game Room SMALLBIZ Smart Answers Success Stories Today's Tip INVESTING Investing: Europe Annual Reports BW 50 S&P Picks & Pans Stock Screeners Free S&P Stock Report SCOREBOARDS Hot Growth 100 Mutual Funds Info Tech 100 S&P 500 B-SCHOOLS Undergrad Programs MBA Blogs MBA Profiles MBA Rankings Who's Hiring Grads | | DECEMBER 22, 1999 TAXES Could a New Tax Change Throw a Spanner into Your Business Sale? Some claim dire effects from accelerated capital-gains levies, but the full impact isn't clear
The rider was intended to raise $1.8 billion to compensate for the extension of some tax credits. The U.S. Treasury says this closes a loophole that allowed what it considered unjustified deferral of taxes — sometimes over decades. The change doesn't affect sales of all companies, nor did the legislation specifically target entrepreneurs. But it has small-business advocates up in arms. The law (attached to the Human Rights Work Incentives Improvement Act, which expands government health insurance coverage for the working disabled) requires business owners that use the accrual method of accounting to pay capital-gains taxes at the time they close the sale of their companies, even if they receive payments over an extended period. Here's the logic: Under the accrual method, businesses account for a transaction (purchase or sale) when it's formalized — not when the money actually changes hands. The same logic is supposed to apply to their taxes — they pay taxes or claim a deduction in the tax period when the deal is inked — even if no cash has been transferred yet. Yet, business owners had been allowed to pay capital gains over time on businesses sold on an installment basis — even if they used the accrual accounting method. The bill doesn't affect businesses that use the cash method of accounting — those that book a transaction when the cash changes hands. So what could this mean for you? Say you sell a business for $1 million. In the past, if the buyer made payments over 10 years, the seller would pay capital-gains taxes over 10 years. Now, sellers must pay all those taxes in the year the deal closes. The law takes effect immediately — with no grandfather clause for deals in process that haven't closed. WIGGLE ROOM. Nine out of 10 small businesses are sold on an installment basis, according to the National Federation of Independent Business. The NFIB has issued ominous warnings that the law will make it much harder to sell a company. True, business owners may demand a larger downpayment to cover their up-front tax liability. But the full impact is far from clear. For one thing, the Treasury may exempt some small businesses from the law when it issues guidelines to clarify gray zones in the legislation. Roger Harris, president of Padgett Business Services USA, a small-business tax franchise based in Athens, Ga., estimates that about 65% of small businesses use the accrual method, while 35% use the cash method. Harris said the drafters of the law erroneously assumed that most small-business taxpayers use the cash method. "There was an attempt to minimize the affect on small business, and by exempting cash-method taxpayers, they hoped to exempt a lot of small businesses. Unfortunately, a lot of small business use the accrual method," says Harris. There is some wiggle room in the law, he points out. A taxpayer could sell the corporation's stock — rather than its assets — and spread the capital-gains taxes out over time. The Treasury allows this because a sale of stock doesn't allow the buyer to benefit from the tax advantages of depreciation that apply to assets. (Over time, an owner can claim an asset's value has depreciated according to a set schedule and deduct that reduction in value from his or her taxes.) But when the assets of a business are sold, they are revalued. That lets the new owner play the depreciation game again. The problem with selling stock is that most buyers want the depreciation benefits that come with assets. The law caught small-business advocates in Washington off guard. Brian Reardon, the NFIB's manager of federal public policy, says the trade group has gone over different scenarios with the Treasury in hopes that it will exempt sole proprietors, the smallest of small businesses. Small-business advocates point out that owners of sole proprietorships are in a gray zone because business income is reported on the owner's individual return. If Treasury doesn't exempt them, "we will have to encourage Congress to pass additional, clarifying legislation," Reardon says. Whatever the outcome, if you're contemplating a business sale this coming year, keep your eye on Washington.   | | |
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