Biden retroactively doubles capital gains tax but retains $ 10 million benefit

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Tax hikes are coming – in fact, they’re already in effect, assuming they’re passed as proposed. The “it’s already working” rule is designed to keep the sale from going under the wire. The success of this strategy depends on the quality of your crystal ball. Make no mistake, these tax hikes pack a punch. The Biden administration’s so-called “Green Book” has nothing to do with the environment, and everything to do with tax hikes. the General explanations of the Administration’s revenue proposals for the 2022 financial year are not simple adjustments to the tax code. Currently, there is a top tax rate of 37 percent. You don’t reach this rate until (as a married couple) you have more than $ 628,300 in taxable income. Biden’s proposal would raise the top marginal rate to 39.6% effective Dec.31, 2021, for couples with taxable income over $ 509,300. The increases in capital gains are more ambitious. Instead of the top rates of 20% plus the Obamacare tax of 3.8%, you lose the capital gain rates entirely if you earn more than $ 1 million. You will now pay 39.6% more the Obamacare tax of 3.8%, for a whopping 43.4%. And here’s the kicker: this capital gains tax increase is already in effect, retroactively on the date Biden first announced his proposal to Congress on April 28, 2021.

Is there any good news in this? The small business qualifying stock provision that has been the darling of the tech industry for decades should be quietly sidelined. You can get up to $ 10 million tax-free this way, or in some cases even more if you are able to creatively tap the limit with the family. But beware, this can also backfire. Among other requirements, the QSBS allocation of $ 10 million is only for the sale of certain shares of a C company. You can read about the qualifications for getting the $ 10 million. tax exempt or deferred tax. Of course, there are many tradeoffs involved in choosing the right entity for small and small businesses, and not all businesses are the same. The traditional choices are companies, partnerships and limited liability companies (LLC), but you have to anticipate.

A few decades ago, when an individual grew too big for a sole proprietorship, a corporation was almost always the logical choice. Over the past few decades, LLCs have become the new normal. They are generally taxed as partnerships. This means that the partners (or in the terminology of LLCs, “members”) themselves pay taxes on the income of the business to their own. clean tax rates. Flow-through tax treatment is always preferred. In fact, entities like Partnerships, LLCs, and S Corporations have been heavily boosted by Trump. Tax Reductions and Employment Act, provision 11011, section 199A. But the same was true for businesses when the corporate tax rate was cut from 35% to 21%, also by Trump. Biden wants the corporate rate to rise to 28%, but it could settle in between. Even at 28%, the C corporation rate is lower than the rate that owners of an S corporation or LLC will pay on their transferred income.

But the problem lies in the two levels of taxation to which C corporations and their shareholders are subject. After all, a C corporation’s income is taxed twice. The company pays tax on its net income. Then, shareholders also pay taxes on the dividend distributions they receive. In contrast, the income of an S corporation is taxed once at the shareholder level. Starting in 2018, the tax law drastically reduced the corporate tax rate paid by C corporations from 35% to 21%. This means that the status of Company C is much better, doesn’t it? Well, compare that 21% rate to how an S corporation is taxed. Personal income tax rates have also been lowered. The highest rate fell from 39.6% to 37%. Then there is the passed-on deduction. If you qualify, it can reduce the maximum effective tax rate from 37% to 29.6%. To many, the idea of ​​a 29.6% tax rate sounds good enough, even compared to the 21% C corporate tax rate.

With a C corporation, you also have to consider taxes at the shareholder level. Dividends are generally taxed at 15% or 20%, depending on income level. Considering corporate tax and shareholder tax, unless you leave all the income in the corporation, you end up paying more tax with a C corporation, even at the 21% corporate rate. . What can be a 10 million dollar problem? And that brings us to the magical advantage of Qualified Small Business Equities (QSBS) that Biden holds in place. It only applies to shares of company C.

For qualifying small businesses (typically up to $ 50 million in assets), shareholders who have held their shares for 5 years may be able to exclude their gain from federal tax. The shareholder limit is usually $ 10 million, and $ 10 million tax free would be nice! If you sell QSBS but haven’t held it for 5 years, there is another QSBS benefit. You can defer the gain by transferring it to a new investment in QSBS. Overall, the QSBS rules can allow founders and other shareholders to be exempt from tax or deferred tax benefits.

S corporation shares are not considered QSBS, and an S corporation cannot have more than 100 shareholders, only US citizens and foreign residents as shareholders. Shareholders generally need to be individuals (and certain limited types of trusts), and the company generally needs to have a calendar year. If there are several classes of shares, only differences in voting rights are authorized. For most small businesses, these criteria are easy to meet. If owners are more comfortable with the form of corporation than an LLC, an S corporation may be a good choice. However, the accounting rules for S corporations are more complicated. In addition, the conversion of C to S can be qualified. An S corporation may be subject to corporation tax if it was previously a C corporation and chose S status within the last 5 years (built-in earnings tax).

Choosing what type of business entity and then playing the tax choices clearly involves tough decisions. It is even more difficult to plan when tax laws always seem to be changing. However, the presence of the qualified small business stock rules as what could be a permanent feature of the tax law makes C corporations deserve another look, even though the 21% tax rate seems likely to increase. . If you are a high income earner and a founder, the QSBS benefits can be hard to ignore.


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