Not Good

As Mr. Biden settled into the White House, and as the Democrats began planning how to best utilize their slim Congressional majority to enact and pay for their sweeping legislative agenda, the principal concern among most owners of successful closely held businesses was Mr. Biden’s proposal to almost double the federal income tax rate applicable to the long-term capital gains recognized by an individual taxpayer.[i]

Such a rate increase would have serious economic consequences for an individual shareholder or partner selling their equity interest in the corporation or partnership through which they operated their business. Whereas the net after-tax sale proceeds, based upon current rates and fair market values, may have been within the range of what the individual owner needed to retire, the proposed rate hike[ii] would force the owner to increase the value of the business by at least a third if they hoped to net the same amount.

Moreover, considering that pass-through entities[iii] are, by far, the most common form of closely held business entity in the country, the individual owners of such a business would experience similar results if the entity sold its assets, and the gain was passed through to the owners.


The last few months have done nothing to alleviate this concern. To the contrary, the summary of the American Families Plan issued by the White House at the end of April,[iv] which was followed by the Treasury Department’s release of the Green Book at the end of May, confirmed that the capital gain rate increase remained a legislative priority for the President; it also expanded the instances in which the tax would be imposed.[v]

Thus, in addition to the individual owner’s sale or exchange of their equity interest in the business, or the pass-through business’s sale or exchange of its assets, the Administration proposed to treat the owner’s intervivos and testamentary transfers of such properties[vi] as an “income taxable event” – a deemed sale – to which the increased capital gain rate would be applied.[vii]

Much Worse

Moreover, although the White House stated the proposed tax on deemed sales would only be applied to gifts made, and to individuals dying, on or after January 1, 2022, the increased capital gain rate would be imposed upon gains from actual sales or exchanges recognized on or after April 28, 2021.[viii]

Fuel to the Fire

If any business owners believed the likelihood of such significant changes to the Code was remote, that belief was certainly shaken by the public’s (i.e., voters’) reaction to the recent revelation[ix] that, for many years, the nation’s most affluent citizens[x] have paid little to no income tax relative to their wealth.[xi]

That is not to say that most successful business owners belong to that category of non-taxpayer. Hardly. But in today’s political environment, the economic success of such individuals seems to be reason enough to tax them at a still higher rate.[xii]

Glimmer of Hope?

And if anyone took comfort from the recent bipartisan infrastructure deal[xiii] that stayed away from tax hikes, and seemed to have been endorsed by the President, well, he appeared to walk that back almost immediately, largely in response to criticism from the more “progressive” – and more vocal – members of his party:

“I expect that in the coming months this summer, before the fiscal year is over, that we will have voted on this bill, the infrastructure bill, as well as voted on the budget resolution. But if only one comes to me, this is the only one that comes to me, I’m not signing it. It’s in tandem.”

However, no sooner had Mr. Biden spoken these words than Republicans threatened to pull their support for the deal. In response, the President tried to assure them that he did not intend to veto the bipartisan measure; meanwhile, progressives pointed to the Republican reaction as evidence of that party’s intention to back out of the compromise infrastructure deal.[xiv]

Forlorn Hope[xv]

In other words, tax increases are still on the table, and the Democrats’ Congressional leadership is preparing to push them through Congress without Republican support using the reconciliation budget process.[xvi]


Notwithstanding the 2022 budget resolutions have not yet been passed by either Chamber of Congress,[xvii] and notwithstanding we are still a few months away[xviii] from the passage of legislation to increase the capital gain tax rate, the owners of many closely held businesses have already sold their business this year, while others are in the process of selling their business or are preparing for, or considering, such a sale before the end of the year.

Probable Motives?

These owners are presumably acting under what I believe is the reasonable assumption there will be a rate hike, effective for sales or exchanges occurring on or after January 1, 2022.[xix]

I believe an additional motivating force is the assumption that the basis step-up for properties passing from a decedent will be eliminated for decedents dying on or after January 1, 2022.[xx] Without that gain-eliminating provision in the Code, why defer the sale of the business until after the owner’s death?[xxi]

Even without regard to the prospect of the rate increase for long-term capital gain, other factors, including the strong performance of the public stock markets and the general economic comeback, may encourage the owners of a closely held business to take advantage of what may be an opportune time to dispose of the business.

Time to Sell?

Indeed, according to various business writers, investment firms[xxii] which were basically inactive during the pandemic now have capital that is ready to be deployed for the acquisition of portfolio companies.[xxiii]

This confluence of diverse factors – the likelihood of an increase in the capital gain rate, the good chance that the basis step-up at death will disappear, the availability of so-called dry powder, together with the relatively low interest rate environment in which we still find ourselves – may have created circumstances in which the owners of closely held businesses, on the one hand, and financial (as well as strategic[xxiv]) buyers on the other, will be eagerly trying to complete purchase and sale transactions before the end of 2021.

However, it is imperative that the owners of a closely held business not allow their concern over taxes to dominate their thinking or to influence their actions to the point of leading them into a transaction that does not make economic sense.[xxv]

It’s the Economics, Stupid[xxvi]

Every sale and purchase of a business, whether from the perspective of the seller or the buyer, is about economics. The transaction involves the receipt and transfer of value between these two parties, with each party striving to maximize its economic return.

Although few items will impact the economics of a purchase and sale more immediately or significantly than taxes, the transaction should only be undertaken if it makes sense from an economic perspective.

Impact of Taxes

That said, the more taxes that the seller parties – i.e., the seller business entity (which, for these purposes, I assume is a pass-through entity, the income or gain of which flows through to its owners for tax purposes[xxvii]) and its individual owners – pay as a result of selling the business, the lower is their economic return from the deal.[xxviii]

Rate and Character. Thus, the sale of a business at a given price is more economically valuable to the seller parties if the gain from the sale is treated as long-term capital gain that is taxed at a rate of 20 percent to the individual owners of the business (the current rate for such gain), rather than as ordinary income that is taxed to the individual owners at a rate of 37 percent.[xxix]

Double Taxation. Likewise, the seller parties will realize a greater economic benefit if only the individual owners are taxed on the sale – as in the case of an asset sale by a pass-through entity[xxx] – as opposed to both seller parties.[xxxi] In some cases, seller parties may be able to by-pass a taxable seller entity by having the buyer agree to pay certain consideration directly to the individual seller-owners.[xxxii]

Deferral. Finally, the seller parties will also be better off, at least from a tax perspective, if they could defer payment of the income tax by deferring the recognition of the gain realized from the sale of the business. Such deferral may be achieved in one of two ways: by deferring the receipt of purchase price, or by receiving equity in the buying entity in a transaction that complies with specific provisions of the Code.

Installment Reporting. The gain associated with the deferred receipt of purchase price is recognized and taxed under the installment method[xxxiii] only as such payments are actually or constructively received.[xxxiv] Such deferral, however, comes at a price: the deferred receipt of some portion of the consideration payable by the buyer carries a credit risk;[xxxv] moreover, the deferred receipt may generate more tax if the capital gain rate is increased during the interim period between the sale and receipt of the payment.[xxxvi]

Reorganizations. The receipt of equity in the purchasing entity or in its parent company may also defer the recognition of gain by the seller parties provided certain statutory and other requirements are satisfied. In the case of a reorganization[xxxvii] involving at least two corporations, the shareholders of the target company must receive a significant portion of their consideration in the form of equity in the buyer.[xxxviii] In the case of a PEF, the seller parties may roll over some of their equity in the business to the tax partnership that is the parent of the acquiring entity in exchange for an equity interest therein.[xxxix]

Either way, the seller parties will participate in the upside, as well as the downside, experienced by their new equity investment. However, their investment will represent a minority interest; thus, they are arguably somewhat worse off than they were before the sale when they at least controlled the business.

Next Steps?

It is not an exaggeration to say that the days of the 20 percent rate are numbered.[xl] Should this circumstance alone accelerate one’s plans to close a deal before the year’s end? Maybe. There are many factors to consider, including how much of the purchase price will be deferred and why.[xli] Then, of course, there is the question of where one expects the rate will end up. Certainly not the 39.6 percent requested by the Administration, though Sen. Manchin – who holds a critical vote – recently indicated he was amenable to a 28 percent rate.

If the owners of a particular closely held business have no present intention to sell the business, then much of the foregoing may not be immediately relevant. Nevertheless, they should be cognizant of these points – the state of the economy, an industry, a market, or an individual business can change overnight, and there is always the possibility of the unsolicited offer.

If some of these folks were planning to make gift transfers of equity interests in the business to family members or to trusts for their benefit, they should consider doing so before the end of the year, provided their remaining exemption amount is enough to shelter such gifts. Notwithstanding my sense that the likelihood of such a transfer’s being treated as a taxable sale beginning in 2022 is remote, I still believe that the reduction in the exemption amount before 2026 remains very much in play.[xlii]

For those businesses that have been waiting for the death of the principal shareholder, and the attendant step-up in basis for that individual’s shares of stock in the corporation, or for the step-up in their share of the inside basis of the assets of the tax partnership (resulting from an IRC Sec. 754 election), now may be the time to reconsider that strategy. The step-up in basis rule is very much at risk. These folks should, instead, look to the rate for long-term capital gain and to the fair market value of the business.

Finally, in the case of a closely held business that was already planning to sell in the near future, or that is in the midst of doing so, the threatened capital gain rate hike will represent a true economic cost the effect of which must be accounted for in negotiating the price for the business (or any adjustments thereto). It should also be considered in determining the structure of the transaction, including the timing of payments; the latter can make a difference in terms of the seller’s net proceeds, and seller parties should not be shy about asking that the buyer gross them up to compensate them for any additional economic cost arising from the seller parties’ agreeing to the buyer’s preferred structure.

In all cases, of course, it is imperative that business owners consult with their tax advisers before making any decision regarding the sale of the business.


[i] From today’s 20% to 39.6%; the same rate to which Mr. Biden wants to increase (from today’s 37%) the federal individual income tax rate for ordinary income.

[ii] I think it unlikely that Congress (specifically, the Senate) would agree to as large an increase as requested by the President, but I am certain they will agree to an increase.

[iii] S corporations, partnerships/LLCs and sole proprietorships (including single-member LLCs).

Of course, they are many closely held C corporations. The lower corporate income tax rate may have something to do with this, though the Administration plans to increase this rate as well, from 21% to 28%. Then there are those businesses that would not qualify as S corporations; for example, because of an ineligible owner or because of the need to issue a second class of stock (such as preferred equity). The concern over employment taxes may also explain, in part, why an LLC is not being used. .

[iv] .

[v] .

[vi] In the case of a testamentary transfer, the gain would be determined without the benefit of the basis step-up that follows the death of an individual owner under current IRC Sec. 1014.

[vii] The gift and estate taxes would also apply.

The proposal exempts from sale treatment the transfer of a business to family members who continue to operate the business. Do you know how few family businesses actually pass from the first generation to the second? Less than one-third. Ice in winter.

[viii] The date on which the President formally announced these proposals.

Thus, gains realized from sales occurring before that date would be taxed at the increased rate if they were recognized on or after that date; for example, as installment payments, as earnouts, or as amounts released from escrow. See IRC Sec. 453.

[ix] While we reflexively dismiss so-called “conspiracy” theories, this confidential information was somehow obtained from the IRS and released, not to a commercial media company that may profit from its publication, but to a tax-exempt not-for-profit described in IRC Sec. 501(c)(3), the tax return of which (on IRS Form 990) describes its most significant activity as follows: “to expose abuses of power and betrayals of the public trust ­by government, business, and other institutions, using the moral force of investigative journalism to spur reform through the sustained spotlighting of wrongdoing.” Look at Sch. O of Pro Publica’s Form 990 for a detailed description.

[x] Including individuals whose names may be described, in some circles, as “iconic” – add them to the modern pantheon comprised of athletes and other entertainers. Go figure.

[xi] Which increased significantly during the economic downturn that accompanied the nation’s efforts to contain the spread of COVID-19, in stark contrast to the number of folks who struggled to make ends meet.

[xii] “From each according to his ability”?

There is a lot more to this. What those who employ this phrase neglect to add is that the 1936 Constitution of the Soviet Union also included the phrase, “He who does not work, neither shall he eat,” which comes straight out of the Bible’s New Testament.

[xiii] Perhaps short-lived; it remains to be seen.

[xiv] Consistent with the President’s first walk-back, but inconsistent with the second, was Ms. Pelosi’s statement last week: “Let me be really clear on this, we will not take up a bill in the House until the Senate passes the bipartisan bill and a reconciliation bill. If there is no bipartisan bill, then we’ll just go when the Senate passes a reconciliation bill.” 

[xv] This refers to a group of soldiers sent into the breach of a wall to clear away the defenders. It was often a suicide mission; hence, “forlorn” hope.

As Shakespeare wrote of the Battle of Agincourt, in Henry V, “Once more unto the breach, dear friends, once more; Or close the wall up with our English dead.” I recommend Bernard Cornwell’s account, Agincourt, of this battle which ended the Hundred Years War.

[xvi] Senator Manchin last week stated that reconciliation was “inevitable.” Meanwhile, Senator Sinema appears to be under sustained pressure from her party to get in line. That said, moderate Democrats in the Senate will probably win a concession or two in exchange for a smooth process. See below re the deemed sale proposal.

[xvii] Their passage is a precondition to the reconciliation process.

[xviii] Mid-to-late autumn?

[xix] That has certainly been the case for sellers whom I have represented this year or to whom I have spoken in preparing for a sale later this year.

This is no different than the reaction of taxpayers to the threatened reduction of the unified estate and gift tax exemption amount at the end of 2012 and again at the end of 2020. There is a “use it or lose it” quality in the approach toward the lower capital gain tax rate.

[xx] I do not believe the Democrats in Congress are ready for the “deemed sale” regime mentioned above, but they can exchange the threat of such a regime for the elimination of the basis step-up at death with similar consequences – i.e., the recognition of the appreciation realized by the decedent when the property is sold.

[xxi] The elimination of the basis step-up should also remove one point of contention among owners from different generations. Think National Starch.

[xxii] For example, the private equity fund (“PEF”). In general, a PEF is not engaged in any “conventional” business. Rather, it is a well-funded investment vehicle that is engaged in the acquisition of conventional businesses (“portfolio companies”). The PEF will often create a holding company (“HC”) that, in turn, will use subsidiary companies to acquire target businesses. Almost by definition, a PEF is not necessarily looking to develop long-term synergies from an acquisition. Instead, it is looking to add to its portfolio of companies which the PEF, in turn, hopes to sell to another buyer in the not-too-distant future, hopefully at a gain for the PEF’s investors.

[xxiii] In general, cash and highly liquid securities that have been committed to this purpose. “Dry powder,” some like to say.

[xxiv] From within the same industry (or one related to it) as the business being sold; often a competitor, or someone seeking to fill a void in their own business. Such a buyer is looking for synergies that would enable them to grow their own business and provide long-term benefits.

[xxv] Much like those individuals who made gifts at the end of 2012 which, in hindsight, were not necessary; when the exemption was restored retroactively, many of these folks sought to rescind the gift (no way) or to buy back the property gifted (thank goodness for grantor trusts).

[xxvi] OK, not quite the phrase that James Carville coined during the 1992 Presidential campaign.

[xxvii] IRC Sec. 1366 for S corporations and IRC Sec. 702 for partnerships.

[xxviii] On the flip side, the more slowly that the buyer recovers its investment in the seller’s business – for example, through tax deductions for amortization or depreciation, and for other expenses – the more expensive the deal becomes.

[xxix] The Administration has proposed to increase this rate to 39.6%; indeed, in accordance with the Tax Cuts and Jobs Act, this increased rate is already scheduled to go into effect beginning in 2026.

[xxx] Such as a tax partnership or an S corporation that is not subject to the built-in gains tax. IRC Sec. 1374. See also IRC Sec. 701 and Sec. 1363(a).

[xxxi] The double tax associated with C corporations that sell their assets. In that case, the corporation is taxed on its gain recognized, and its shareholders are taxed when the corporation distributes to them its after-tax proceeds.

[xxxii] For example, the purchase of individual goodwill, or the payment of compensation for their “services” or for the use of their individually owned property.

[xxxiii] IRC Sec. 453. The gain from the sale of certain assets does not qualify for installment reporting; for example, depreciation recapture.

[xxxiv] These include, for example, the assumption of a debt, payments under a promissory note, earnouts, as well as the release of funds from an escrow deemed to be owned by the buyer.

[xxxv] Though there are ways of mitigating this risk; for example, a third-party guarantee or a standby letter of credit.

[xxxvi] A taxpayer in these circumstances may be able to elect out of installment reporting and choose to be taxed on its entire gain realized in the year of the sale.

[xxxvii] Described in IRC Sec. 368.

[xxxviii] The continuity of interest requirement.

[xxxix] IRC Sec. 721.

[xl] Though I will grant that it sounds theatrical.

[xli] Are we talking about a buyer’s note (a financing issue), or an escrow to cover indemnity obligations?

[xlii] You may recall it was not mentioned in the Green Book, though it figured prominently during the presidential race.