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Capital Tax Hikes Looming: How Companies Soften the Blow

Capital Tax Hikes Looming: How Companies Soften the Blow

It is once again small EU countries like Hungary, Cyprus, Ireland and Malta who may act as the last bastions against G7 tax fixing as both OECD and G7 cheerleaders seek to draw all countries into their vision of higher corporate taxes for all. Then off course, there is the issue of capital gains tax, as the tax base expansion creeps to infinity:  “Doubling the top capital gains tax rate from 20% to 40% may make for a good progressive talking point but its economic effect would make it hard for small businesses and hard working Americans, as it would create a significant reduction of financing for small businesses,” Mercatus Center senior fellow and economist Veronique de Rugy warned.

Capital Tax Hikes Looming: How Companies Soften the Blow 10

“Big Business” and “the 1%” aren’t the only ones affected

“Capital gains are the reward for risky investments. Cut the return on these investments and you will get fewer of them. New and innovative companies may never see the light of day for lack of capital,” de Rugy explained that the higher the tax rate grows the lower incentive to invest in risky investments becomes. This could stimulate investments into, “safer investments like government bonds.”

Chris Edwards, an economist at the Cato Institute, is in agreement that hiking capital gains could strangle investment. “The reward that angel investors receive for putting their name and money into startups is a capital gain five or more years down the road. Raising capital gains taxes would prompt angels to shift their money to safer investments, starving the economy of fuel for dynamic industries such as technology.”

Certified financial planner Chris Diodato points out that a change in the market may occur, “if the capital gains rate increases and isn’t made retroactive to 2021.” If the rate increase becomes law and goes into effect retroactively a whole new set of events could occur. He points to a long term concern that the stock market would have to cope with an increase in corporate tax. “The combined tax rate, with the corporate tax and capital gains tax, can put a bit of a damper on long-term stock prices in general.”

Soften the blow of higher taxes on trust income

Denis Burns, experienced in Federal Income Tax, recommends the following steps to help soften the blow higher taxes will have on trust income.

  • Use grantor trusts: intentionally defective grantor trusts are designed so that the trust’s income is taxed to the grantor, thus the trust itself avoids taxation. If personal income exceeds the thresholds that apply based on your filing status, then using an IDGT won’t work to void tax increases.
  • Change investment strategy: the trustee can shift investments into tax-exempt or tax-deferred investments, this strategy can help to ease the tax burden.
  • Distributed income: a trust, when making distributions to beneficiaries, can pass along ordinary income and capital gains in some cases, which is taxed at the beneficiary’s marginal rate. One way to avoid higher taxes is to distribute trust income to beneficiaries in lower tax brackets.

Of course, when in doubt it is best to consult with a financial advisor.

Reduce Capital Gains Tax when selling business

Capital Gains Tax differs from Corporate Interest Tax in a very significant way. Corporate Interest Tax is based on the profits of the business whereas Capital Gains Tax is levied on a large sale, such as the sale of a business or property. There are some strategies to help soften the tax blow when selling a business.

Structure the sale to benefit a purchase

The sale of a business is often structured as an “asset sale” instead of a direct sale of the entire business. In this scenario the business entity remains the property of the seller who recognizes gain or loss on various components of the business sale rather than the entire interest. Some parts of the sale will be taxed as ordinary income. This sale structure often is more favorable for the buyer, who may be able to write off the purchase faster than when buying an entire business entity. It is worth to note that this type of sale is likely not feasible where long-term contracts are held in the name of the business.

Installment agreement can reduce tax owed

An Installment Sales Agreement can help to reduce the amount of Capital Gains Tax. This can be especially useful if the profit you’ll receive will likely push you into a higher tax bracket. Under this agreement the buyer pays a portion of the sales price yearly as opposed to one lump sum. This makes it possible for the seller to adjust their yearly income to fit within their financial requirements. The installment sale model can be used for asset purchase as well.

It is interesting that big names like Tesla (Elon Musk) chose Texas over California for better taxation. Whether you are a Texas LLC or a Fortune 500 company, there are measures to help ease the tax burden. A financial advisor would be able to tailor your tax strategy, as each individual business has unique needs.

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