With a new presidential administration comes new budgets, talks of tax changes and discussions on how these changes will impact American businesses. The waste and recycling industry has been increasingly active in M&A over the past year, and, at least in part, this increased activity could be attributed to fears of a potential increase in capital gains taxes.
But what does this mean for business owners? Curtis Kim, M&A tax principal for Los Angeles-based GHJ Advisors, breaks down the potential tax increases and how an increase in capital gains could influence some business owners’ decisions to sell or stick it out.
Waste Today (WT): What are the potential changes we might see with capital gains taxes, and when might these take effect?
Curtis Kim (CK): President Biden proposed the American Families Plan (AFP) on April 28. One of the items in the AFP is a proposal to increase the capital gains tax rates for those earning more than $1 million ($500,000 for married individuals filing separately), the same with ordinary income tax rates, which are also proposed to increase from 37 percent to 39.6 percent for the highest marginal rate.
A month later, on May 28, the Biden administration issued its 2022 Fiscal Year Budget, including an explanation of revenue proposals (including the increased capital gains tax). What surprised many is the proposal included capital gains tax rates increases for gains recognized after April 28, 2021. In other words, this would increase the capital gains rate on transactions that already happened, as well as future ones.
While no one has a crystal ball on how high the capital tax rates will go and when such changes may be effective, many anticipate a somewhat moderate increase perhaps effective in 2022. As we are living in an increasingly fluid world, it would not absolutely shock us if things play out as laid out in Biden’s 2022 budget.
WT: What would this mean for business owners thinking of selling their businesses?
CK: The M&A market has been very active for the past few years. There are many business owners looking for liquidity, retirement or a strategic business combination. At the same time, financial and strategic buyers are looking for investments fueled by the low-interest-rate environment. In addition, after the 2020 presidential election, there has been even more interest by business owners for a liquidity event in anticipation of increased tax rates. If the capital gains tax rates go up as proposed in Biden’s budget, it is likely that nearly a 20 percent tax rate increase may discourage some business owners from selling. However, we anticipate that business owners will quickly pivot and utilize some of the deferral provisions allowed in the tax law. There may be an increased appetite for tax-free reorganizations, tax-deferred rollovers, qualified small-business stock exemptions, employee stock ownership plan (ESOP) transactions and dividend recapitalizations, to name a few.
WT: Do you think the potential escalation in capital gains taxes has brought business owners to the table quicker than they might have originally been willing to to avoid this over the last year?
CK: We think so. We noticed a significant uptick in business owners selling their businesses, especially after the 2020 presidential election.
WT: How might capital gains impact M&A dealings in the waste and environmental services industry, specifically?
CK: For the past few years, there has been a fair bit of consolidation in the waste and environmental services industry. We have also seen more private equity players enter the market. This activity is being driven largely by more complex regulations and the need for significant capital outlays to stay relevant in the market. If the capital gains tax rates increase, the structure of the deals will change, but we still anticipate a frothy market. There are still several tax deferral strategies that may work for business owners depending on the facts and individual circumstances. While this may not provide as much cash as an outright sale for cash, owners can now wait and see if the capital gains tax rates will change again.
WT: What advice would you offer to business owners concerned about when is the right time to sell?
CK: As the old adage goes, taxes should not drive business decisions. A prudent business owner serious about selling his or her business can talk to an investment banker experienced in the industry to ascertain up-to-date market trends, valuation data and help perform a self-check on whether the company is ready for sale. Your CPA and attorney can help assess what needs to be done before a sale and how to best position the company from accounting, business and tax perspectives.
Even if the capital gains tax rates end up going up, it is not the end of the world. There may be creative ideas to alleviate the impact. A good tax advisor can go a long way.