The Net Investment Income Tax, which our friends at the IRS put into effect in 2013, takes an extra toll on business owners who sell their businesses; and for that matter, on most higher income taxpayers and any moderate income taxpayer whose income increases suddenly in a given tax year.
What is the Net Investment Income Tax?
The Net Investment Income Tax (“NIIT”) is a 3.8 percent federal tax on certain income of individuals, estates and trusts whose modified adjusted gross income or “MAGI” exceeds certain threshold amounts. Common forms of investment income are interest, dividends, capital gains and passive business activities such as rental income or income derived from royalties. Generally, wages and income from an operating business are NOT considered net investment income.
For individuals, the MAGI threshold is $250,000 (married filing jointly) and $200,000 for single filers. Taxpayers with MAGI over the threshold are taxed at a flat rate of 3.8 percent on all net investment income, in addition to other taxes!
When you sell a business of any significant value, NIIT will likely affect your tax liability in the tax year(s) in which you receive payment. Individuals report (and pay) net investment income tax on IRS Form 1040; while estates and trusts use Form 1041.
So, what should business owners do?
If you are considering the sale of a business or business interest, it is important that you fully understand the tax implications of a sale beforehand. There are strategies that you can use to minimize your tax liability if you take action early enough and/or structure the sale in certain ways. Contact your tax advisor to estimate your tax liability and find out what can be done to maximize your after-tax proceeds.
Exit Strategies are not tax professionals, and we do not provide tax advice. However, tax issues arise in nearly all of our exit planning, valuation and M&A brokerage engagements, so we are well aware of them. If you are looking for an experienced CPA or tax advisor to analyze the various federal and state tax issues related to a business transaction and recommend appropriate tax minimization strategies, we can recommend one or two. Feel free to Email Al Statz or call him at 707-781-8580 for help.