What is the federal capital gains rate for selling a business?
October 25, 2002
Subject: 2001 capital gains rate
A question in regard to the article on your web site. I sold a business in 2001 which I owned for over 5 years. I have no basis as the business was inherited. Could you tell me what my capital gains federal rate would be? Also, would the value of the business at the time ownership was transferred to me be considered help in reducing the capital gains tax?
Thanks for your response.
Date: Wed, 16 Oct 2002
You haven't provided enough information for me to answer your question. I highly recommend that you seek help from a professional tax return preparer. The answer can vary for a proprietorship, a partnership interest, an S corporation or a C corporation.
Generally, the tax basis of inherited property is equal to the fair market value at the date of death or alternate valuation date. Inherited property is generally treated as held more than one year when sold after a death. Accounts receivable for a trade or business does not receive a new tax basis. You also may have basis adjustments for depreciation allowed or allowable after the date of death.
The maximum federal tax rate for long-term capital gains is generally 20%. Most people will not qualify for the new 18% rate for capital assets held for more than five years until after 2005. Taxpayers in the 10% or 15% brackets may qualify for the 8% capital gains rate for 2001. There is a worksheet on page 8 of the Schedule D instructions showing whether you qualify.
The same maximum capital gains rate (20%) applies for computing the regular tax and the alternative minimum tax (AMT). Taxpayers with large long-term capital gains are often subject to the AMT because state income taxes aren't allowed as a deduction when computing the AMT.
When you sell a business, part of the income can be for depreciation recapture, taxed as ordinary income (38.6% maximum rate for 2002), or capital gain attributable to accumulated depreciation for real estate, subject to a 25% maximum rate.
State income taxes can also be significant. For example, California has a maximum income tax rate of 9.3% with no break for capital gains. If a sale results in only a long-term capital gain subject to the 20% maximum federal AMT rate plus the 9.3% maximum California rate, the total would be 29.3% (not considering the tax benefits lost for other deductions that are disallowed for AMT.)
Other special rules can apply, depending on the details. That's why you need to have someone help you with your particular facts. Since the tax rules for the sale of a business are complex, it's a good idea to get tax advice when structuring an agreement for the sale.
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