Exit and Succession Planning – The Challenges of What’s Next

According to studies conducted by the McKinsey Global Institute and Oxford Economics, it could take five years or longer for businesses to recover to pre-COVID economic levels. Although the businesses are starting to rebound and are expected to improve throughout 2021, owners who are planning to sell their company or implement a succession plan must be aware and actively manage the many evolving business climate challenges.

Potential Impact of Selective Biden Administration Federal Tax Proposals

Proposed Increase in Capital Gains Tax Rate 

President Biden is proposing a capital gains rate increase to 37% (from 20%) under existing law. The rates would be assessed on individuals with adjusted gross income that exceeds $500,000 for single taxpayers and $1,000,000 for married taxpayers filing jointly. Including a separate 3.8% tax on net investment income, the combined federal income tax rate on long-term capital gains and dividends would be 40.8% if legislation were to be passed. Separate state tax rates could put the combined rate north of 50% in some locales.

Observation: The Section 199A qualified business income deduction is not a deduction in arriving at adjusted gross income. Further, in 2022 the Section 461(l) $500,000 excess business loss limitation will again be in place. Net operating losses will be limited to 80% of taxable income. These types of loss limitation provisions have the impact of increasing adjusted gross income and, therefore, increasing the likelihood of the higher tax rate applying to gains and dividends. 

The Green Book, a publication that explains the proposed tax proposals recently released by the U.S. Department of the Treasury, indicates the higher tax rate will apply to “gains” beginning on the date of President Biden’s announcement (presumably on or around April 28, the date of his first address to Congress). Note that it does not separately address when the increased rate would apply to dividend income, but specific use of the word “gains” may imply that the effective date would not be until after December 31, 2021. 

Potential Impact of Proposed Changes to Gift and Estate Asset Transfers

The donor or deceased owner of an appreciated asset would realize a capital gain at the time of transfer. For a donor, the amount of the gain realized would be the excess of the asset’s fair market value on the date of the gift over the donor’s basis in that asset. For a decedent, the amount of gain would be the excess of the asset’s fair market value on the decedent’s date of death over the decedent’s basis in that asset.

The Green Book appears to indicate that the tax would be borne by the party making the gift or the estate. Exceptions to the general rule include:

  • $1,000,000 per-person exclusion (up to $2,000,000 for married couples) for property transferred by gift or held at death; 
  • Transfers in death to a U.S. spouse (prominently omitted are transfers to spouses in divorce);
  • Transfers to charity (though certain transfers to split-interest trusts would be taxable);
  • Certain tangible property; appreciation on household furnishings and personal effects (but not collectibles) would be excluded; 
  • Gain on sale of a principal residence; the $250,000 ($500,000 married filing joint) gain on the sale of a principal residence would be excluded; and
  • Small business stock under section 1202 would continue to be excluded.

While gain on the appreciation of family-owned businesses is not excluded, the Green Book does indicate that payment of the tax would not be due until the interest in the business is sold or the business ceases to be family-owned and operated. 

The proposal would also allow a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death, other than for liquid assets like publicly traded financial assets or for businesses for which the deferral election is made. The IRS would be authorized to require security at any time there’s reasonable need. That security may be provided by any person and in any form deemed acceptable by the IRS.

PPP Forgiveness Eligibility for Change in Ownership Companies 

The sale of your business could affect PPP forgiveness eligibility. In November 2020, the U.S. Small Business Administration (SBA) issued a procedures notice to lenders that carry with it borrower responsibilities when there’s a change of ownership, which the SBA defines as a transaction that falls into one of three categories:

  1. The sale or transfer of at least 20 percent of common stock or other ownership interest of a PPP borrower, including to an affiliate or an existing owner of the entity;
  2. The sale of at least 50 percent of a PPP borrower’s assets; or
  3. A merger of a PPP borrower with or into another entity.

All transactions require that if the new owner has a separate PPP loan, the borrower and the new owners are responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements by each PPP borrower. In the case of a merger, the successor is responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements with respect to both PPP loans.

Additionally, prior to closing any change of ownership transaction, the PPP borrower must notify the lender in writing. Depending on the circumstances, different procedures may be required and could include obtaining approval by the SBA, which carries a decision timeline of up to 60 days or establishing an interest-bearing escrow account. The risk for the borrower is that if they don't follow SBA change of ownership guidelines, the PPP loan could be at risk for not being forgiven and/or payment may be accelerated. 

Looking Ahead 

With the economic revitalization still taking shape, here are a few actions to consider to help guide you through these uncertain times.

Constantly update forecasts and contingency plans. Create rolling forecasts that incorporate new data and identify areas of risk, particularly with regard to cash flow. Develop trigger points to take further action based on defined business results.

Track costs and inflationary pressures from suppliers. Communicate this impact on your business to customers. Add language to contracts and bids requesting price increases based on elevated input costs, with supporting information sourced from published data, like that from the U.S. Bureau of Labor Statistics.

Evaluate vendors and purchasing policies. Your entire supply chain is affected. With inflation for input materials continuing to constrain the industry, take time to review and update your purchasing policies. Create a list of all vendors and evaluate whether you’re getting the best deal for the volume you purchase. Understand which vendors can provide you with the supplies you need and pivot, as necessary.

Divest of excess assets. Optimize your inventory levels to match demand. Part ways with unnecessary equipment or other assets. While you may not receive optimal prices, cash is king right now.

Remain current on the impact and opportunity of legislative changes. In light of the constantly changing landscape, it’s important to make sure you understand the implications of current laws. Speak with your professional advisors to ensure you’re taking advantage of available opportunities.

Exit and succession planning is one of the most important strategies you’ll need to implement throughout the life of your business. Whether you’re ready to start today or in 10 years, it’s never too early to begin the discussion.

About Schneider Downs Exit Planning and Succession Advisory

Our Exit Planning and Succession Advisors are comprised of advisory professionals from five practice units—assurance and tax advisors, business advisory, technology advisors, corporate finance and wealth management—to deliver seamless, fully integrated exit and succession solutions. Download our Exit Planning and Succession service overview to learn more or contact us today to get started.



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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

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