It’s not what you make, it’s what you keep. This adage is especially true when business owners are approaching an exit. The sale of a closely held business can often trigger larger than normal taxes, not only from higher marginal rates but also from higher capital gains rates, the net investment income tax, phaseout of credits or deductions, and local wealth taxes like the “millionaires’ surtax” in Massachusetts.
To gain an edge against these costs, business owners should look at their existing investment portfolio structure – something that might otherwise take a backseat when the focus of attention is on the business itself. Implementing a proactive tax-management investment strategy can reduce capital gains that might otherwise add to the tax burden. In addition, via a separately managed account (SMA), tax smart trading may create capital losses, which can reduce taxable gains from the business sale.
An SMA is a professionally managed customized portfolio of individual stocks. Unlike a mutual fund where your money is pooled with others, in an SMA you directly own the stocks in the portfolio, allowing for more control. Here’s how an SMA can be effective at limiting or reducing capital gains, particularly for a business owner who is about to sell their business:
Tax-Loss Harvesting
Within an SMA, the portfolio manager can actively sell securities that have declined in value to realize losses. These losses can offset the capital gains realized from the business sale, thereby reducing the overall taxable gain.
Deferring Capital Gains
The portfolio manager can structure the timing of sales within the SMA to spread out capital gains over several years, rather than realizing them all at once. This can help manage the tax burden by keeping the business owner in a lower tax bracket or minimizing exposure to higher capital gains taxes.
Minimizing Short-Term Gains
SMAs can be managed to avoid short-term capital gains, which are taxed at a higher rate than long-term gains. By holding assets for longer periods or strategically selling long-term investments, the portfolio manager can reduce the overall tax impact.
Donating Appreciated Securities
An SMA can facilitate the donation of highly appreciated securities to a charitable organization. By donating these securities instead of selling them, the business owner can avoid capital gains taxes on the appreciation, while also receiving a charitable deduction for the fair market value of the asset. A Donor Advised Fund (DAF) could also be used, to enable gifting over time.
Family Wealth
An SMA can facilitate gifting appreciated assets to family members who may be in lower tax brackets, thus reducing the overall family tax burden. This is especially useful in the context of estate planning and wealth transfer strategies post-business sale.
By using an SMA, a business owner can take advantage of sophisticated tax management strategies to reduce or limit capital gains, optimize the timing of income, and integrate these efforts into a comprehensive financial plan. This is particularly beneficial when dealing with the large capital gains associated with the sale of a business.
If you are a business owner and haven’t worked with an advisor to understand the plan you need in place to exit your business on your own terms and maximize your outcome, our Wealth Management teams would be happy to help. Let’s Talk.
Click to learn more about Heritage Financial’s Advanced Planning Solutions.
Business Owner Looking to Monetize
