What the Proposed Capital Gains Tax Means for Amazon FBA Sellers
Yesterday President Biden unveiled his new economic package, called the American Families Plan. The proposal made headlines earlier this month when it was revealed that it would include nearly doubling the capital gains tax for wealthy individuals. The top federal rate could potentially hit highs that haven't been seen since the 1920s.
Since 2013, the capital gains tax has held steady at 20% for high earners, and a maximum of 23.8% including additional surtaxes. Under the proposed legislation, it would reach 39.6% for individuals with incomes over $1M, but it could go as high as 43.4% when including the Medicare surtax.
Source: Tax Foundation
So what does the proposed capital gains tax mean for FBA sellers?
According to FE International and many federal tax experts, the increase of the capital gains tax isn’t a question of “if” but “when,” which will lead many FBA business owners to look for an exit strategy in 2021.
In short, if you’re considering selling your FBA business, now is the best time if you don’t want to pay twice as much in taxes.
The top rate will never be as low as it is this year, and because of this now is a good time to sell. If you have a capital gain now, you are going to pay 20%. You’ll want to get it in as quickly as possible, assuming (an increase in the capital gains tax) will be effective at the day of the enactment.
— Sidney Kess, CPA, J.D., LL.M, a nationally recognized tax expert and author of hundreds of tax books
The federal rate is actually just half the story, as many states also have additional capital gains taxes, and many of these are also projected to increase. The only states that do not have a capital gains tax are:
On the flip side, total tax rates for New Yorkers and Californians could top 50%.
How much will the capital gains tax cost typical FBA business owners?
So state rates aside, let’s say an FBA seller wants to sell their business in 2022, after the new capital gains tax is in place. They’ve been consistently reinvesting their profit into their business, and they have much of their wealth wrapped up in inventory.
The sale might be the first time they’ve been able to meaningfully cash in on the success of their business.
While they might have been subject to the 20% capital gains tax in 2021, let’s see how the 43.4% rate impacts their take-home cash.
First they need to understand their Seller’s Discretionary Earnings (SDE), which is essentially the cash flow and benefits a business has generated over a period of time, typically a year. Here are more details on how to calculate SDE (and potentially increase your valuation by millions of dollars).
Your SDE determines your business’ total value. So, let’s say their SDE is $500,000. These days, many aggregators are offering multiples of ~3.5x, though the deal may be subject to earnouts or stability payments which can increase the total value.
Let’s keep things simple and stick with the 3.5x multiple. This would mean that the seller would receive $1,750,000 before taxes, the vast majority of which would be considered capital gains.
Though they were not a millionaire before the deal, they are afterwards, which would likely mean that the $750,000 over $1M would be subject to the 43.4% capital gains tax. Assuming the seller had negligible non-capital assets involved in the deal, this comes out to be $563,500 in taxes paid.
Meanwhile, if they had exited their business in 2021, before the increase, they would have only paid 23.8%, if we include the Medicare surtax. This comes out to be $416,500 in taxes paid.
By simply waiting one year, the FBA seller cost themselves an additional $147,000 in taxes.
You can still exit your business before the capital gains taxes go into effect
Unless you think you can meaningfully increase the value of your business to offset such a massive increase in taxes, 2021 is the best time to sell your FBA business. This is especially true if your business saw a pop due to COVID-19.
If you can see yourself selling your business any time in the next four years, it might be worth it to consider a sale now. Yes, you could potentially continue to grow your business, but will that be able to offset the massive spike in taxes that you’ll be certain to encounter?
Biden’s proposal was only just announced last night, and it hasn’t even been deliberated on the floors of congress. It will first have to pass. There has been speculation that the legislation, when passed, could be made retroactive January 1, 2021. However, it is more likely that these taxes would only apply for the 2022 tax year. This means that there is still a window for FBA sellers who are looking to maximize the sale of their business if they can close before the end of 2021. They should start understanding how to calculate their SDE now to help accelerate the process. They should also work with an aggregator that can close a deal quickly, typically within 30-45 days.
Now, there's nothing certain about the outcome of this proposal. There’s a chance that the proposal will be modified significantly before it goes into effect. Perhaps a smaller increase will pass, such as 25% to 30%, instead of the proposed 39.6%. Even so, any increase at all should be enough to prompt businesses to seriously consider selling their businesses sooner rather than later.
Find Your Next Perch
If you’re interested in selling your FBA business to maximize your earnings before the new capital gains taxes, sell to the best.
We pride ourselves on being fair and transparent with our sellers. In fact, in a survey with the business owners who have sold to Perch, 100% said they would be extremely likely to recommend Perch to a friend. Over 30% of our acquisitions have actually come as a result of seller referrals. Find out why by reaching out to us today!