Tax law changes help sellers

August 1, 2003 By    

The tax liability created when retail propane business owners sell their company can be significant. The amount owed as the result of a sale is always an eye opener for shareholders of small businesses ­ retail propane companies being no exception.

As a general rule, the tax liability generated by the sale of a retail propane business ranges from 25 to 50 percent of the total amount of the transaction. The wide range depends upon the characteristics of the entity selling and the structure of the transaction.

The good news is that the new tax bill passed by Congress and signed by President Bush (the Jobs and Growth Tax Relief Reconciliation Act of 2003) provides some relief to sellers of small businesses by cutting tax rates in a meaningful way. Like the tax code itself, the code changes are
very complex. I will attempt to hit the most significant points as they relate to the tax liabilities to the seller of a retail propane business.

Three primary areas of the new code affect the tax computations for sellers of retail pro- pane businesses. We will be dealing only with the Federal Income Tax Code, and not any state or local income tax issues.

Capital gains tax

The most significant impact is the reduction of the capital gains tax rate for individuals from 20 percent to 15 percent on assets held more than one year. This change was effective May 6, 2003 and applies to the sale of any asset, including the sale of stock. As written, the code reverts
back to 20 percent in 2009.

In “pass through” entities such as sub-chapter ‘S’ corporations, partnerships and certain limited liability companies, the tax consequences of the entity are treated at the shareholder level, so the capital gains reduction applies.

Let’s look at a simple example of a sale off assets from a sub-chapter ‘S’ corporation. A $100,000 sale of an asset held for more than one year with a tax basis of $50,000 creates a capital gain of $50,000. If sold before May 6, the federal tax liability is $10,000 ($50,000 gain times the old 20 percent rate), and the federal tax liability if sold May 6 or later is $7,500 ($50,000 capital gain times the 15 percent new rate). This $2,500 reduction amounts to a 25 percent reduction in the amount of federal tax owed.

The capital gains rate for ‘C’ corporations remains at 34 percent. Thus, the sale of assets from a ‘C’ corporation would still have the full 34 percent (inside gain) liability.

But in the instance of liquidation (outside gain) of a ‘C’ corporation possibly after the sale of the assets ­ it is taxed at the new lower rate of 15 percent. The tax code does not eliminate this double taxation (meaning the ‘inside gain’ and ‘outside gain’) of a sale of assets and liquidation of the corporation, but it does somewhat lessen the blow.

Income tax rates

The top individual income tax rates dropped from 38.6 percent to 35 percent. Often, a portion of the total amount of the sale is paid in consideration for a non-competition agreement from individuals. While the reduction is not of great magnitude it does provide incremental benefit to a seller, particularly in certain types of transactions.

This change was effective Jan. 1, 2003 and reverts to 39.6 percent in 2011.

Dividend tax rate

The dividend tax rate was reduced from 38.6 percent to 15 percent. This change also was effective Jan. 1, 2003 but reverts back in 2009.

While this tax is not directly triggered as the result of a sale of a company or its assets, this significant reduction can be extremely meaningful for shareholders who desire to get cash and earnings out of ‘C’ corporations. Until now, the high tax rate has been a barrier to shareholders who desire to get cash out of the corporation.

In summary, the most significant impact of the tax changes are:

  •  Sellers of assets from sub chapter ‘S’ corporations have obtained
    a meaningful 25 percent reduction in their income tax liability.
  •  There remains no significant relief from the dreaded double taxation
    issue facing sellers of assets from ‘C’ corporations.
  •  The significant cut in the dividend rate will provide a better avenue
    for ‘C’ corporations to pass cash and earnings to shareholders. h

Carl Hughes is vice president of business development for Inergy LP. He can be reached at 816-842-8181 or by e-mail at Chughes@InergyServices.com.

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