The capital gains tax increase from 20% to 39.6%, proposed by President Joe Biden to fund his American Families Plan, would not only significantly affect individuals who make more than $1 million annually, but also financial advisors who are looking to sell their businesses, according to Jamie Hopkins, managing partner of wealth solutions at Carson Group and a finance professor at Creighton University.
Of the proposed tax increases, the capital gains tax hike has the largest potential impact to most advisors, he said Thursday in the webinar "A Changing Capital Gains Tax and What Else to Consider During a Sale."
The conversations he has had with financial advisors in recent weeks certainly reflected that concern, he said, noting many of those talks were centered on the proposed capital gains tax increase and the impact it would have on a sale of their businesses.
After all, an advisor "might not have a million dollars of recurring income every year, but when you have these liquidation events, those could be the things where all of a sudden, people are pushed into this very high" tax bracket, he said.
On top of the capital gains tax increase, you also have to factor in the 3.8% net investment income tax that was passed as part of the Affordable Care Act, Hopkins noted. As a result, "all of a sudden, you can see that you could be losing a significant portion of the value you think you have in your business," he said.
Research indicates that many people will just hold on to their business or any other huge assets and leave them for their estates banking on a step-up in basis, he said. Therefore, an "increase in capital gains without the removal of step-up in basis in essence doesn't generate much revenue," he said.
If a firm is valued at $6 million today, at the current 20% tax rate, the owner of that business would have to pay a $1.2 million capital gains tax bill. Under the proposed 39.6% rate, that number jumps to more than $2.3 million, Jason Carver, managing director of mergers and acquisitions at Carson Group, pointed out by email before the webinar.
During the webinar, Carver pointed out that if an advisor's firm has $300 million in assets under management, annual revenue of $3 million, and $1 million in EBITDA, that business owner would pay an effective tax rate of 23.13% on a sale, including the net investment income tax rate, and have net proceeds of $5.7 million. Under the proposed capital gains tax increase, there would be $1.176 million lost, he said.
The business would have to see a 28% growth rate "to just get back to breakeven," and that is difficult, Carver said: "To be honest, I don't know how many businesses out there, especially at this size, are growing at 28% per year."
