With the 2024 general election fast approaching, tax considerations for business owners are becoming more critical as uncertainty looms over future tax policies.
The potential for major tax changes in 2025—such as higher capital gains taxes and the expiration of the 20% Small Business Deduction—could have a serious impact on after-tax proceeds from company sales and their overall net worth.
While it’s impossible to predict exactly what tax policy will look like post-election, the risks are clear: waiting to sell could result in substantially lower after tax proceeds, even if your business grows in value between now and then.
Capital Gains Taxes Directly Reduce Business Sale Proceeds
One of the biggest tax considerations for business owners is the possibility of a higher capital gains tax rate.
The Harris campaign has proposed raising the current 20% capital gains tax rate to 28% (or more).
In a simplified example, if you were to sell your business for $5M, under the current 20% rate, you would walk away with $4M in after-tax proceeds.
But at a 28% capital gains rate, your after-tax proceeds shrink to $3.6M— $400K less, with no change to the business's value. Even if you grow your business, a tax increase would still erode that growth.
For example, if your business value appreciates to $5.5M, but you are now taxed at 28%, the after-tax proceeds are $3.96M— over $400K less than if you sold today at the current tax rate in a transaction valued at $5M.
All else being equal, a higher capital gains tax directly reduces the cash you walk away with, regardless of how well your business performs.
Expiration of the 20% Small Business Deduction
Another one of the major tax considerations for business owners is the potential expiration of the 20% Small Business Deduction, which has been a vital tax savings for many small and mid-sized business owners.
This deduction effectively reduces your taxable income, giving you more cash flow to reinvest or take home.
If it is not extended in 2025, your taxable income will likely increase, and with it, your tax bill.
The loss of this deduction could reduce your after-tax income while you still own the business, and if it occurs together with a higher capital gains tax rate, after-tax cash to business sellers would be severely impacted if it aligns with a business sale transaction.
The Cost of Waiting
Waiting to sell with the hope of getting a better price or improved market conditions might sound appealing, but if tax policy changes, you could lose more to the government than you gain from business growth.
Revisiting our previous example, assume your business grows 10% from $1M in EBITDA today to $1.1M over the next year.
If the valuation multiple drops slightly from 5.0x to 4.5x due to deteriorating market conditions, your business might still be worth approximately $5M. But if the capital gains tax rises to 28%, your after-tax proceeds would be $3.56M, approximately $436K lower than if you sold today, even though your business grew!
This demonstrates how waiting, even with growth on your side, can lead to a reduced financial outcome when tax rates rise. If the business does not grow, the downside impact is even more acute, to state the obvious.
Acting Now Could Be the Smart Move
As the 2024 election adds more uncertainty to the tax landscape, business owners are facing a critical decision: sell their companies now under the current tax scheme or wait and risk a higher tax bill in the future.
For Sellers who are contemplating a sale sometime in the next 1 - 5 years, selling sooner, while the rules are clear, would allow you to lock in your proceeds and protect your net worth from potential post-election tax changes.
Given the uncertainty, securing today’s favorable tax rates could be the best way to ensure you maximize your take home proceeds from selling one of your most important assets.
Ready to Discuss Your Business Goals?
If you are considering selling your business in the next 1 – 5 years, we’d appreciate the opportunity to speak with you further.
