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Paul Martin

Good afternoon to all of you, and welcome to another episode of Paul Martin's crucial Conversations. Few weeks back, I did a video that described to all of you what some of the new tax policies, the Biden tax policies that have been proposed. What kind of impact that could have on a merger or an acquisition in the rehab industry? We decided that this topic is so important for all of you right now that we have with us today Tommy Klein. It's a CPA from Bowman in company, CPA firm Bowman and company has three locations in South Jersey. And we have Tommy here with us today. Why? Because he and his constituents have really just taken a deep dove into this not only what the proposed tax policy means, but how it will impact in an actual hypothetic rehab deal. So, Tommy, welcome. I cannot tell you how excited I am to have you here today.

Tommy Kleinhans

All right, Paul, thanks as always. It's always a privilege getting to share some tax knowledge with you and the rest of your audience and as well as, you know, say hi to everybody at Morton Health Care Advisors. You know, we love working with you guys and you have all ready to dig deep into some tax knowledge. And let's go through a rehab consideration and see now what the implications would be with the current tax law and as well as what the implications could be with the new Biden tax policy.

Paul Martin

That's awesome. That's awesome. Again, if for your audience, if you could walk through, you know, kind of give us an update on where this new tax policy the proposed tax policy is in the approval process, what you expect to see over the next few months leading into 20, 22 And then, yes, if you could hit us with a rehab deal and what it would look like under the current tax policy versus the new proposed tax policy That would be awesome. It's all yours, Tommy.

Tommy Kleinhans

All right. Thanks, Paul. So we'll try and run through the American Families Plan real quick, just to give you guys an update. This was unveiled by President Biden around April 28 to $1.8 trillion infrastructure plan and includes child care funding, some infrastructure spending and also vehicle tax policy. So we're going to try and concentrate today on the tax policies and how it would affect the individuals that are potentially selling their rehabs. Right now, it's currently in Congress and legislation about whether this act's actually going to be passed, as some of you may know, it has to go through the House of Representatives with a majority vote that needs to be passed by the Senate. Senate usually needs 60%. But there's a reconciliation law type of mechanism that can be used so that the majority is all we need in the Senate. Now, right now there's 50 Democrats, 50 Republicans. So they're going to need all 50 Democrats on board in order to pass this law. So I wouldn't be surprised and our peers wouldn't be surprised if there's a couple tweaks and changes to this tax policy before it actually gets passed and implemented and goes into law.

Paul Martin

Well, thank you. That would be wonderful.

Tommy Kleinhans

Now it's time to get into the actual details of the law, because there are a lot of tax savings for certain taxpayers now in the country and at the same time, there's also a lot of tax business because when one gets one has to also add. So some of the reductions and we won't get too far into it. They're increasing the child tax credit. They're increasing the child and dependent care tax credit. They're basically increasing the amount of credit that a person can receive and also the type of thresholds that are around these tax credits. And they're also increasing the premium tax credit, which has to deal with the Affordable Care Act. And receiving health insurance from the marketplace. Now, now that they're giving the credits, where are they actually going to add this tax to that? They're still receiving the revenue and that they can still implement and collect. So the top you know, the one that everybody knows about, they're raising the top marginal tax rate. It's currently at 37% for ordinary income. They plan on raising this rate to 39.6%. So I'll include the tax tables so the audience can go through slides later and you can actually look through the tax brackets. But that's one aspect of this tax policy. Another aspect that is a big deal for your rehab considerations is that they plan on taxing long term capital gains that are greater than $1,000,000. Ordinary tax brackets. So if you're already at an AGI that's greater than $1 million, you're already in that tax top tax bracket of 39.6%. So if you have any type of long term capital gain that comes from a rehab sale and you're greater than that $1 million threshold, you're going to be getting hit with a 39.6% tax rate on that sale, along with a 3.8% net investment income tax rate. That's looking at 43.6% tax on any type of long term capital gain if this foreign tax policy gets best.

Paul Martin

Tom, let me just let me let me just ask one quick thing about the million dollars threshold. Does that mean I have to have earned $1,000,000 in salary distributions? Or does it mean that with the value of the sale plus what I earn is over $1,000,000?

Tommy Kleinhans

The value of the sale plus what you've earned. So let's say you're at $900,000 of ordinary income. And now with the sale, you have a $3 million capital gain. You have $100,000 of your capital gains tax that that 20% still. But then once you hit the million dollars threshold, now the rest of your game gets taxed up to 39.6%. So this is the big deal. This is what the IRS is big revenue collectors that would be stepping off the tax credits that they're giving back to other tax payers. Got another deal that is important for your rehab owners is they plan on making the net in this investment income tax for that 3.8% tax that currently isn't taxed on anybody that owns an active business. And most of your rehab owners or taxes partnerships or taxes as corporations so that income ends up flowing through as an individual. Well there's going to be an extra 3.8% tax on that income as well. And last but not least, this tax it's a $1.3 trillion infrastructure plan buy and plans on giving $80 billion to the IRS so that they can gear up and and try and find those tax payers that have been skipping or, you know, adding personal expenses or doing things that are in not the gray area, but in the black or white area. However you'd like to say it, but that area that people are just not allowed to be doing things. They're doing So let's go through an actual scenario and go through a situation of a rehab order selling their business the way out the numbers so that you guys can actually get an idea of where somebody would be with a sale, with their basis would be, and what the taxes would be with the current law and with the tax law. So we have a company, let's say, started 15 years ago with one click when they originally started. It's now expanded to ten clinics. This person who is really driven female or male, made their way to the top. Now they have $10 million in revenue. They have a partner, so they have a shareholder. So there's two people that are dealing with the sale of the clinic has an EBIDTA, which is your earnings before interest taxes depreciation and amortization of $2 million. For a time sake, let's just say your valuation you get nine times or even so the cash purchase price of your business would be an $80 million cash purchase price. Now since you share the business with another shareholder, your share would be a $9 million sale. So keep that under consideration. And I say you for the sake of argument, you are a married individual, your spouse is a W-2 employee. So there is no other type of taxes that are going on on your return besides the wages you receive from your business, the wages your spouse's fees, and then you have a job So the first thing we have to look at is your basis in the company, because your basis is going to determine how much your long term capital gain is. So let's say your basis is any contributions you made to the business, any income that business made, and then any distribution you took out for personal use or for taxes to be paid on the business. So let's say your initial cash contribution was $1,000,000. Let's say the company has had $11 million in profit over the last 15 years. So your share of that 11 million is five and a half million dollars of profits. And let's say you took out $1.5 million to cover your share of the profits that what's your basis at $5 million. So then your long term capital gain, that's going to end up hitting your tax return from the sale of your rehab is $4 million because again, you have $9 million from the sale. Your basis is $5 million long term capital gain, $4 million.

Paul Martin

So you will get you're going to get tax on $4 million based on 9 million of of essentially funds that would be coming to them. The tax is going to be on 4 million because their basis is 5 million Exactly.

Tommy Kleinhans

And since they've already paid taxes on those profits, they don't need to pay that tax.

Paul Martin

Understood.

Tommy Kleinhans

Got it ends on the at the table. If you're a partnership or an S-Corp that a constant flowing through to you for the last 15 years. So you're not going to get double double going on that kind of thing.

Paul Martin

Understood.

Tommy Kleinhans

So now let's look at the comparison. So your total tax prior to the capital gain would be around three 30 $340,000 with the current tax law. So that's with the income tax brackets at 37%. Your business is not getting hit by that 3.8% net investment income tax. And let's say you had 10,000 qualified ordinary dividends that's getting taxed at 20% as well. It's getting tax up the long term capital gain rates. Now you're proposed tax law before the capital gains even gets introduced. Your proposed tax is already around 380 to $390,000. So it's an extra $50,000 in taxes prior to the capital gain. Reason why you're out of business. You have passed through and called that and comes getting hit with an extra 3.8% and then your tax rate as well for your top income is now at 39% 39.6% instead of 37%. So now let's get to the details and let's add this capital gain. So before you're already at million dollars of income, you know, you have the $900,000 of income flowing through from your partnership or S-Corp, you have your W-2. So now let's add the $4 million of capital gain from the sale of your rehab. So we have the current cycle top tax rate for a long term capital gain. 20%, $4 million to 20%. That's $800,000. You also have to pay it in that investment income tax of 3.8%. So that's an extra $50,000, give or take That's gonna leave you around $950,000 of additional tax on top of what you already had to pay with your ordinary trade or business income. Proposal. You already have over $1,000,000 of ordinary income with the 900,000 that you make from your rehab from the $150,000 in W-2 income you have from your, your business, you have your spouse's wages, and then you may have your dividends as well. So the $4 million gets hit with 39.6% tax. Now, because you're over the million dollars. That's some new long term capital gains tax rate. Even once the ordinary tax rate, 1.5. $8 billion would be a capital gains tax. And that's before you even get hit with again, you're still going to be paying that hard and $50,000 in that investment income tax as well. So your additional tax with the capital gain, with the proposed tax law, $1.73 million, long term capital gains tax with current tax law by $52,000. Your difference right $850,000.

Paul Martin

So close to double oh.

Tommy Kleinhans

Yeah. It's about 80% increase.

Paul Martin

Yes. And so when I did my quick little video a couple of weeks ago, I said what you can anticipate is to pay close to double in tax. I wasn't too far off, was I, Tommy?

Tommy Kleinhans

Now, I mean, the other point from before an hour that so yeah, if everything stays as it is and the policy gets passed through legislation, Biden ends up signed on the law. Yeah, it could potentially be a sale of a business. And so of paying your your long term capital gains rate of 20%, you're not going to be stuck with the 39.6% yeah. And that's on top of that depending on what state you're in certain states. We're both New Jersey guys. New Jersey has a 10% tax as it is for taxpayers that earn greater than $1 million. There's other you can be a Florida resident be very lucky and fortunate that tax but in your take home is not going to be the $8 million or the $9 million for so you may have to pay Yeah we're looking at potentially 43% of federal tax and on top of that another 10% state tax. I mean that's 54% of your your sale right out the door. So we'll I'm in the state of New Jersey or the state of whatever state you reside in.

Paul Martin

Tommy, before I have you kind of give advice for business owners out there. I want to make sure, you know, if any of you out there are, you know, have contemplated a sale or just want some tax advice on, okay, I'm going you know, I'm considering doing, you know, going through a process. I would hope that you would call us, but you really need some tax advice. You just want you know, you have a complicated company. You have multiple partners. We will give you and provide you with Tommy and Bowman and company. Their information so that you can give them a call and request that tax help and potentially, you know, utilize them and assist you in this. So Tommy, again, this is still all the proposal stage, as I heard you say, it's going to take 50 out of 50 Democrats to thumbs up this to have it passed in full. And so what I heard you say is that what we'll probably see is some iteration of this it may not be exactly as it's been proposed but you know just in conversation around your office, does anybody in your office think that the tax policies are going to stay exactly as they are today?

Tommy Kleinhans

But at least we're probably going to see some of the Tax Cuts and Jobs Act which was implemented in 2017 repealed. And again I'm trying to provide facts here. I'm sure Trump is on buys as possible because, you know, for one taxpayer, this may be a huge benefit for another. This may be the worst thing that could happen to them. And the same thing happened back in 20, 18 when Donald Trump passed his act. And so, you know, things are going to change most likely especially if one party can control the legislation process as well as the executive process, because that it just makes it more of a streamlined process to pass these types of tax policies. So yeah, so the thing you definitely want to do is now consult your tax advisor. You definitely want to understand the basis that you have in your rehab, because that affects tremendously the amount of tax that you're going to end up paying on any type of sale.

Paul Martin

You know, and I think, Tommy, that for folks that are, you know, considering selling their business at some time in the future, that most of them I would say probably don't have a real good handle on what their basis is. So that would be a reason in itself because again, the tax is not paid on the full purchase price. It's paid on the, you know, the purchase price minus the basis and the net. So I think that would be a really important fact for business owners to get.

Tommy Kleinhans

Absolutely. And I'd be happy to provide a link that includes, you know, if somebody wants to go on to a website and see how the partnership tax basis is calculated, how your S-Corp tax basis is calculated based. So you can kind of get an idea of what you would be looking at come tax time when in the year that you sell your business.

Paul Martin

Yeah, absolutely. Absolutely. I appreciate that. I appreciate that. So, Tommy, we have a lot of business owners out there. Their hearts are beating much faster right now than they were when we first started talking today. What advice would you have for business owners out there today? We're well, it's almost we're more you know, we're heading towards you know, we're in June. So what advice would you have for for four rehab business owners out there today?

Tommy Kleinhans

Well, the first thing I'd like I apologize if I may just sweat a little more since you have the stress through, you know, a year and a half or struggle with it. And it seems like people are finally now feeling comfortable to get back out there, especially for health care industry, and be able to provide the service that you're providing, whether you're going all the telehealth or going back to your physical locations. The biggest thing you need to know is you need to see clarity. You need to talk to your most trusted advisers, whether that's you tax guys, your attorneys, any type of people that now have a strong hold on understanding what's going on in the world and what's revolving around your business, whether that's, you know, if you sell this year compared to next year, knowing what type of differences there are, because we went through, you know, an easy example, there could be one or two weeks that end up completely throwing things off one way or the other. So it's all about making sure that you have clear communication, clear clarity, clarity with your advisors and and from their understanding where you're going to be, what your succession planning is and what your end goal is. All of the life implications, the legal implications, the tax implications, and everything else.

Paul Martin

Absolutely. Absolutely. Tommy, I really appreciate it. And we're going to continue to reach out to you as we get closer and closer to a final decision on this, because I think there's going to be a lot of folks out there that are going to need your help.

Tommy Kleinhans

Yeah, absolutely. Fine. Again, I really appreciate the privilege to be on here and speak to your audience. And yes, I mean, day by day, we discussed prior things are changing by the minute, by the second, by our So there could be a meeting going on right now in Congress where a couple of people are trying to decide. Thanks as always.

Paul Martin

Absolutely. So for all of you out there, if you have questions and you are not sure if this is the right time for you to make that move. Have us allow us to take a look at your company and determine whether this year is the right year for you to potentially put that business into the market and consider a partnership out there. Just click below and we'll talk. I appreciate all of you joining us today. And I look forward to talking to you in the very near future. Thank you.