by Chris SwiecickiHow Taxation Laws Affect Stock Market Prices
When you hear news of possible corporate tax rate increases, your first thought may be how this will hurt your company’s bottom line. In addition to concerns about reduced profits, you might wonder how changes in taxation laws affect stock market prices. In many cases, stock prices go up after a federal tax increase. Still, many worry about what will happen if the economy stalls.
Business owners do not have much influence over tax laws. They do have choices about reducing their tax burden. For example, selling stocks is taxable. Smart stockholders know the ins and outs of capital gains, tax credits, and taxes on dividends. Knowledge of tax laws related to the sale of stocks is especially important for those looking to sell their businesses.
The History of Taxation Laws Affecting Stock Market Prices
President Joe Biden’s 2024 budget proposal includes an increase in the corporate income tax from 21% to 28%. Although the proposed tax hike is sizable, if passed the corporate tax rate will still be lower than the top rate of 35% corporations paid before 2018. Congress is unlikely to approve new corporate tax laws, but the president’s proposal has reignited dialogue on corporate tax rates.
The last corporate tax hike was in 1993, when the government raised the rate from 34% to 35%. The tax rate stayed the same until Congress passed the 2017 Tax Cuts and Jobs Act and lowered the corporate tax rate to the current 21%. Most corporations and their taxation law experts find ways to pay the government less than the statutory tax rate. The effective federal tax rate for large corporations decreased from 16% in 2014 to just 9% a year after the 2017 tax cuts.
Despite what one would think, markets have had strong returns following tax increases over the past 50 years. Fidelity compared tax increases with stock market trends from 1950-2021. The study included corporate, personal, and capital gains tax increases. Key findings include:
- The S&P 500 index had higher than average returns after tax increases 13 times.
- Stocks rose every time the corporate tax rate increased.
The study’s findings are interesting, but Fidelity does not have enough information to draw a conclusion about how taxation laws affect stock market prices. When corporate taxes have increased and stock prices also went up, the economy might have been stimulated by factors such as job growth, defense spending, or low interest rates. The added sales revenue from a booming economy often give companies what they need to counter higher taxes and come out ahead.
Selling Stocks Is Taxable Under Capital Gains Laws
While you cannot affect stock market prices or tax increases, you can reduce your tax liability related to selling stocks or your business. The Internal Revenue Service levies capital gains taxes when you sell stocks:
- Long-term capital gains taxes apply to the sale of assets when you have owned a business for one or more years. Long-term capital gains have lower tax rates than other sources of income. The three tax rates are income-based: 0%, 15%, or 20%.
- Capital gains for businesses less than one year old are taxed at ordinary income tax levels.
To figure the taxable gain of the sale of your pass-through entity, subtract the seller’s basis from the purchase price. The proceeds will be taxed as capital gains.
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Tax Laws Related to Selling a Business
Before getting serious about the potential sale of your business, find out how the structure of a sale will affect both your federal and state taxes. Failure to structure the sale properly may have a significant impact on your tax bill, and hence on your retirement fund.
The sale of a business usually is classified as a long-term capital gain for which the seller is responsible. The long-term nature of the gain adds up. If you started your business 15 years ago with $75,000 and are selling it for $5 million, your capital gain is $4.25 million. In this example, a federal capital gains tax at a 20% rate is $850,000.
Businesses may be sold in one of two ways: As a stock offering or a sale of assets. Most sellers prefer stock sales while buyers want to buy the assets. The seller will pay capital gains taxes.
Strategies for reducing taxes when selling stock differ by corporate structure. The owners of pass-through entities—Limited Liability Companies (LLC), partnerships, or S Corporations—usually sell their personal stock shares to transfer the company to a new owner. They pay capital gains taxes on their personal income taxes and the company does not owe additional taxes.
A buyer may be adamant about buying the assets of a pass-through entity, not stock, because of the tax advantages for them. The seller can go ahead and sell the assets and not worry about paying any taxes beyond capital gains.
In contrast, selling assets instead of stock has negative consequences for owners of C Corporations. When a company sells its assets, it must pay taxes at both the corporate and shareholder level. If the shareholders sell their stock, they receive a direct payment and pay capital gains tax. Sellers often need help from a taxation attorney to negotiate with buyers for the deal that is in their best interest.
Taxation Attorneys Help Business Owners Cut Their Tax Burden
If you are planning to sell your business, ask for advice from taxation attorney Christopher Swiecicki. He helps business owners design an exit strategy with the lowest tax burden possible. Some tactics Christopher recommends include:
- Spread out your tax liability. You can ask the buyer to pay in installments to eliminate your need to pay all the capital gains taxes in one year.
- Watch the calendar. Do not sell a business before it is at least a year old to benefit from the lower rates of capital gains taxes.
- Do not rush into a sale. Negotiate with confidence when the buyer wants to make a deal that works for them but not you. Take your time and stand your ground.
- Reinvest in the Opportunity Zone Fund. You can defer capital gains tax through December 31, 2026, by investing capital gains from the sale of a business into an Opportunity Zone, a federal economic development program. The investment must be made within six months of the capital gains.
Selling your business may be the largest financial transaction you will ever make. Feel confident you are structuring the sale to minimize capital gains taxes with help from taxation attorney Christopher Swiecicki. Call our office at (636) 778-0209 to arrange a free consultation.
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