The Biden administration has promised that family-owned businesses and farms won’t suffer under its proposed tax hikes on the wealthy, the lynchpin of a $1.8 trillion package of spending and tax cuts aimed at boosting workers, families and children.
In fact, financial advisors say, a giant tax bill can eventually materialize for owners who decide to make a quintessentially American move: cash in on a lifetime of hard work by selling the successful family enterprise.
The tax increases are “a huge negative for somebody who’s built up a net worth in that business, if they sell that business,” says Duane Donner, the founder and CEO of Founders Advisors, a mergers-and-acquisitions firm in Birmingham, Alabama.
President Joe Biden says his plan would shield business owners from a
His plan has a special exception for family-owned businesses, which range from aluminum screen manufacturers to mom-and-pop restaurants to the maker of
There’s more. The second punch in Biden’s proposal is a near-doubling of the current 23.8% capital gains rate (including the 3.8% Obamacare levy) to 39.6% (plus the surcharge) for those making at least $400,000 a year, with the start date retroactive to April 28. That’s also Biden’s top proposed individual rate (the current is 37%).
When it announced
That might seem to be a partial reprieve for the nearly 7 million family-owned businesses in the US — around
Treasury’s reasoning, says Ali Hutchinson, a managing director and senior wealth planner at Brown Brothers Harriman in New York, is that many owners won’t have piles of cash on hand to pay a new tax bill all at once when they sell, so giving them 15 years can ease the pain. By contrast, paying upfront could require more money than the business actually earns in a year, and thus force the owner to sell business assets or take on new debt — moves that could weaken or kill the enterprise,
That’s probably not as big an issue for the deep-pocketed heirs to the Mars, Cargill and Chick-fil-A
Here’s what advisors say are the big puzzlers:
What happens if an owner dies suddenly but the heir can step in only months later to run the business, because she’s already tied up running another company and needs time to sort things out? Would she now immediately owe capital gains tax on the appreciated value of the inherited business — that she will eventually run — since it began decades ago?
What happens if a family owns a business but contracts its daily operations to a highly-skilled professional — a vineyard, say, that hires a Silicon Valley executive as CEO?
What if a family business — such as a restaurant that wants to open new locations — brings in an outside investor, either with a minority or majority stake?
Are real estate holdings considered a family business?
What if no heirs want to actually run the business but still want control of it?
“We don’t know,” says Hutchinson. “There is a lot of legislating to do.”
Data on how many businesses pass to the next generation is wildly varying:
Here’s a look at how things could change. Say, in a simplified example from the EY report that Financial Planning modified to reflect the current total capital gains rate and Biden’s proposed increase, someone started a wine distribution company two decades ago. The business initially had no market value. When that founder dies in 2025, his daughter inherits the company, now worth $550,000 with annual revenues of $40,000.
Under current law, the company’s value for tax purposes would be “stepped up” to that new amount, and the daughter wouldn’t owe capital gains taxes on her inheritance. Next, say she sells the distributor five years later for $710,000, when its annual income has grown to $50,000 and she’s ready to cash out. Under current law, she would owe the 23.8% capital gains tax on its appreciation under her wing, or more than $38,000 ($710,000-$550,000 = $160,000; $160,000 x .238 = $38,080).
Under Biden’s proposal, she wouldn’t owe tax upon inheriting and running the business her father started — but neither would it get a stepped-up basis. Which means that when she eventually sells the company for $710,000, she would owe capital gains tax, at Biden’s higher rate, on its total gains since it started from zero. That’s a tax bill of more than $281,000 ($710,000 x .396 = $281,160). Under the White House’s plan, her tax bill is more than seven times higher. She can pay it over 15 years, at more than $18,700 a year, but may not have the cash from its sales.
When someone who earns perhaps $300,000 a year sells a company after 20 years, “the liquidity event is going to push them over $1 million in taxable income” — the level at which Biden’s higher capital gains rate kicks in — says Alyson Nickse, a CFP at Crestwood Advisors, an RIA in Boston. “The pain is going to be largely on the high-income earning families, but also lower-earning families when they’re looking at the sale of a family business.”
