March Letter to Clients

Dear clients and friends,

It’s March and spring should be just around the corner. Some days it feels like it, some days not so much. As we all know it will happen sometime.

In this month’s letter, we would like to bring you up to date on two topics. 1) Things you should know about capital gains and losses. 2) Use of buy-sell agreements between co-owners.


Before we talk about gains and losses let's explain what a capital asset is. A capital asset is property you own for personal use or own as an investment. Capital assets include things like your car, home and investment assets like stocks and bonds.

A capital gain or loss is the difference between what you sell the asset for and your basis in the asset. Typically, your basis in a capital asset is what you paid for the asset. For example, if you sell a stock for $3,000 and you purchased the stock for $2,000 you have a capital gain of $1,000.

Starting in 2013, a new tax was introduced called the Net Investment Tax. All capitals are considered net investment income and may be subject to the 3.8% net investment tax.      

Capital losses are only deductible on sales of investment property such as stock. Losses incurred on the sale of personal property, such as your home, are not deductible.

Capital gains and losses fall into two categories. They are either long term or short term depending upon how long you held the property. If you held the property for more than one year, your gain or loss is long term. Less than one year and your gain or loss is short term.

Now we will introduce the term Net Capital Gains. If your total long-term capital gains exceed your total long-term capital losses you have a net capital gain. If your long-term gains are more than your short-term losses, you have a net capital gain.

Tax on capital will vary depending upon your income. The maximum capital gain rate is 20%. However, most taxpayers pay 0-15% on capital gains. A tax rate of 25% and 28% can apply to certain types of net capital gains.

Capital losses are deductible, but the deduction is limited. If your net capital losses exceed your capital gains the net loss is limited to $3,000 per year. The limit is $1,500 if you are married and file a separate return.

However, all is not lost. The excess of capital losses over the annual limit can be carried forward to the next tax year. The loss is then treated as if it occurred in that next tax year and netted against that year gains and losses.



Buy-sell agreements are just that- An agreement between business co-owners where an owner or business agrees to buy the interest of another co-owner and they agree to sell their interest. A well drafted buy-sell agreement can help the business owners: 1) transform their business ownership interest into a more liquid asset, 2) prevent unwanted transfers in ownership, and 3) avoid expensive and lengthy estate tax valuations with the IRS after the death of one owner.

There are three basic types of buy-sell agreements:

Cross-Purchase Agreement. A contract between all owners that says when a certain event happens such as a death or retirement of a co-owner, the remaining owner or owners are legally obligated to buy the withdrawing or deceased owner's interest in the business.

Redemption Agreement. An agreement between the business entity (corporation, partnership or LLC) and all the entities owners. When a triggering event happens, the business entity is legally required to buy out the withdrawing owners in the business. The entity redeems the interest.

Hybrid Agreement. This agreement is a combination of the first two. After a triggering event, a hybrid agreement might give the remaining owners first right of refusal to buy the withdrawing owner's interest. If this option is not exercised, the entity itself is legally obligated to buy out the withdrawing owner. The agreement could be the other way around. The entity has the right of first refusal with the remaining be obligated to purchase the interest if the entity doesn’t purchase the interest.

Most buy-sell agreements give the right of first refusal to the remaining owners and the business entity. If this option is not exercised, the interest can be sold to an outside party. If no outside party steps forward, the entity or remaining owners are legally obligated to purchase the withdrawing owner's interest.

Buy-sell agreements have three primary goals:

1) make sure there is a willing buyer for the ownership interest when a triggering event happens,
2) prevent owners from transferring their ownership to an outside party without the consent of the other owners, and
3) to provide greater certainty about the federal estate tax outcome after the death of an owner.

Let’s talk about the third goal of providing certainty of federal estate taxes valuation. The buy-sell agreement must have an acceptable method for valuing the owner's business interest when the triggering event occurs. Some commonly used valuation methods include an appraised fair market value, fixed price per share or a multiple of earnings or cash flow. The method of valuation needs to be part of the agreement and all parties must abide by it.

There are other things that must be considered when drafting a buy-sell agreement. How will a purchase of a withdrawing owner be funded? Cash from the individuals or the entity, loans, etc. One common funding vehicle is life insurance. This is where owners and entities purchase a life insurance policy on each other. This will provide funds to purchase the withdrawing owner's interest.

Buy-sell agreements are complex documents and a team of experienced professionals should be used to consider all aspects of the agreements. Attorneys to draft the documents, CPA’s to consult on the tax aspects of the agreement and an insurance professional to help provide a funding vehicle.

If you have questions about capital gains and losses or would like to talk about a buy-sell agreement for your company, give anyone at our office a call. They will be happy to answer your questions.




St Cloud, MN