If you are looking to sell your insurance agency in the near future, one of the things you’ll need to be aware of is the possibility of paying a significant capital gains tax on the sale.
Currently set at 20%, there are concerns that it could nearly double to 39.6% for households earning more than $1 million a year, which is what President Biden said he would like to see the tax increased to during a speech before a joint session of Congress in April.
Capital gains taxes are levied on a large sale, such as the sale of a property or business.
If you sell an agency that you’ve owned for more than 12 months, the proceeds will be treated as long-term capital gains.
Currently, the long-term capital gains tax rate is 20% for single households with more than $445,850 in taxable income in 2021. For households earning $40,001 to $445,850, the capital gains tax rate is 15%. For $40,000 or less, there is no capital gains tax.
For short-term holdings of less than 12 months, the applicable tax rate is 22% for households earning more than $81,050 a year. This increases to 37% for households earning more than $628,300.
With that in mind, if you are considering a sale of your agency and are concerned Biden’s plan will come to fruition, you can take steps now to sell and pay lower capital gains.
Before you sell, though, there are a number of issues you need to be aware of in terms of capital gains taxes. It’s a good idea to familiarize yourself with how the IRS will treat proceeds from the sale of your agency and how the sale must be structured.
In this article we’ll look at the overall tax treatment of a sale, and we’ll delve into how to structure the sale in a subsequent article.
Two types of sale
There are typically two types of agency sale: A stock purchase, or an asset purchase.
Most often the sale is an asset purchase (around 90% of all sales), which would include purchasing the agency’s assets (including the book of business).
A stock sale would be a sale of the seller’s corporation, an arrangement that is relatively uncommon because the sale can expose the buyer to the corporation’s past liabilities, including taxes and any lawsuits.
An asset purchase also gives the buyer more flexibility, and they can take a tax deduction for the value assigned to those assets over what is the useful life of the assets, under IRS rules.
We will focus on an asset purchase, since it’s the more common, and the tax implications.
Tax issue one
What you end up paying in capital gains taxes will depend on the type of company that your agency operates as, such as:
- Limited liability corporation,
- Sole proprietorship,
- C corporation,
- Partnership, or
- S corporation.
For LLCs and sole proprietorships, profits from an asset sale will be taxed only once for capital gains. Under IRS code, these entities are not taxed separately from the owner or owners. Profits from the sale will have to be reflected in the owner’s personal tax returns.
S corporations and partnerships have a similar tax structure. When you sell assets through an S-corp. or partnership, the individual owners or shareholders are each generally responsible for paying the taxes on their personal income tax returns.
Like LLCs and sole proprietorships, S corporations and partnerships don’t have to pay another set of taxes on an asset sale on the commercial income tax return of the company.
The C corporation structure, however, results in capital gains being taxed twice: once for the company and once for the owner(s).
The IRS considers corporations as separate entities from their owners. Hence, the corporation would have to pay the corporate tax rate on capital gains. Then each shareholder in the company will also have to report their share of capital gains on their personal income tax returns depending on their ownership share in the company.
Understanding how capital gains are taxed is the first step in preparing for the sale of your agency, and it’s important to understand the tax implications before you take the next step in the sale process.
If you have multiple owners, you will need to huddle with one another to discuss these issues so you can put together a viable plan to sell the agency to best benefit you in terms of taxes.
And, in light of Biden’s announced plans to push for a higher capital gains tax for individuals earning more than $1 million, you may want to consider your plans going forward.
However, it’s still unclear if his plan will go anywhere in a deeply divided Congress, which would have to pass legislation changing the tax laws.
Next month, we’ll look at how an insurance agency’s asset sale should be structured under IRS rules.