Capital gains can be a double edged sword be smart about managing your assets to minimize costs
Taxes are inescapable part of owning a business, but you can be smart about how you manage them. Understand the advantages and disadvantages of capital gains to maximize your bottom line.
Selling an asset at a gain is always something to celebrate, but how you manage the capital gains tax associated with the investment can have a major impact on your business:
- Capital gains occurs when a business (or individual) sells an asset such as real estate, machinery, or stock share at more than it cost to buy.
- Capital gains are taxed at a favorable federal tax rate of only 20%, but only certain types of businesses can take advantage of that rate.
- Though having extra cash on hand from a capital gains sale is a plus, more complex and time-consuming accounting may be a drawback speak with your companys CPA to understand all of the implications.
They say nothing is certain except death and taxes, and the capital gains tax is no exception.
The capital gains tax occurs when a business sells an asset (machinery, stock investment, real estate, etc.) at a greater price than the company originally paid for it. But capital gains is not a zero-sum game; depending on how you manage it and the subsequent investments you make with your gain, the capital gains tax can offer distinct advantages and disadvantages for the business owner to consider.
The main advantage of capital gains
The main advantage of capital gains lies in the fact that it offers a more favorable federal tax rate of 20% for both individual and married tax payers. The business capital gain is reaped by the business in the form of a K1 pass-through taxation form, which is issued by an S corporation or LLC to transfer the financial benefit to the individual owners instead of the company.
Only certain types of businesses can take advantage
That being said, not all businesses can take advantage of this beneficial 20% rate. C corporations, for example, are not able to leverage capital gains since unlike an S corporation or LLC, the income does not flow through to the shareholders or members on an individual level.
Instead, the capital gains tax is taxed on the business level at the ordinary (higher) corporate tax rate. Before you sell an asset which you anticipate earning a profit on, it is always worth speaking with your accountant or financial advisor to understand your options and the implications that the sale will have on both your business and your personal income tax rates.
If your business is able to take advantage of capital gains, one key benefit you can expect is to have more cash reserves available to invest in the business since there will be less tax paid than on typical income.
However, one drawback to consider is that since the investments are on the companys books, a more detailed accounting might be required, which could cause the companys financials or tax return to be delayed. Again, it is important to speak with your accountant to consider how the timing of your sale may affect your financial/tax processing.
Who's managing the investment?
In certain cases, it can be argued that unless the company has a designated person/team/service managing the investments, it might be best for the business owner to personally make the investments, rather than investing through the business. This can be achieved by a distribution to the owner and subsequent personal investment, which will keep the investment wholly separate from the business so as not to complicate company accounting.
In short, capital gains can be very beneficial to a business, but as with anything, there are also some pitfalls to consider. Business owners anticipating a potential capital gains scenario are advised to work with their CPAs to understand the impacts of a capital gains sale and ensure smart investments to benefit the business.
About the author
Alexander J. Hart of Cuban American decent is principal and founder of Hart Vida Raffo. With over 25 years of experience, Alex specializes in the areas of tax strategy and planning, business process improvement, and capital consulting. Whether advising on capital and financing strategy or consulting for privately-held professional services firms, Alex has the expertise and practical know-how to help any company optimize their business processes and make tactical financial decisions. He began his career at IBM in sales operations and accounting. He was a Controller for the N.Y. Post, has been a CFO for a medical device company, and has written a tax column called “Ask the Tax Guys” for Micro-Cap Review. Alex is a professional member of A.L.T.A. (Affiliated Lawyers of the Americas), a member of the National Association of Tax Preparers, and is a contributing author and mentor at Latin Business Today. Alex graduated from St. John’s University with a B.A. in Spanish and his M.B.A. in Finance. He obtained his accounting degree from Pace University.Website