Restaurant Owners Take Note: Capital Gains Tax Legislation Proposed for 2016

The proposed legislation to impose a new capital gains tax in Washington State (House Bill 2224) should have little or no immediate effect upon a typical restaurant operator. This is because restaurant owners usually recognize ordinary income from their restaurant operations, not “capital gain” as defined in the Internal Revenue Code and in this bill.

However, the sale of a restaurant business at a substantial profit would likely produce a capital gain, which could be taxed under this proposal. To the extent a restaurant owner or investor sells a restaurant or sells his stake in a restaurant, that sale might produce capital gain, which could be subject to this excise tax.

In other words, this proposal would hit restaurant investors upon the sale of their restaurants, and would have little or no effect upon the typical restaurant owner/operator/investor who derives regular income from the restaurant over the course of the restaurant’s operation. But would this legislation discourage investors from investing in restaurants with the expectation of building up the value of the enterprise and selling out for a profit? Almost certainly. Would this have an adverse impact upon employment in the restaurant industry? Again, almost certainly.

  • Would the proposal apply to all businesses? An excise tax of 5% of capital gains would be imposed upon individuals, whether engaged in business or not. That is, the capital gains tax would apply to individuals with ownership interests in all types of entities disregarded for federal tax purposes, including but not limited to partnerships, limited liability companies, S corporations, trusts, limited partnerships, etc. The excise tax would not apply to “C” corporations, because capital gains realized by C corporations are not “passed through” to their owners; however, a shareholder of a C corporation who realizes a capital gain upon the sale of stock would be subject to the tax on that gain.
  • Just sole proprietors? In addition to sole proprietors, the excise tax would apply to individual partners and LLC “members” to whom long-term capital gains are “passed through” from their businesses.  And, as noted above, shareholders of C corporations would be subject to the tax on gains from the sale of their stock.
  • How would they differentiate between businesses and individuals?  The tax would apply to individuals, whether the individuals are engaged in business or not.
  • What type of transactions would incur a capital gain?  Sale of any property (real property, shares, LLC interests, etc.) except for (1) accounts receivable, (2) inventory, and (3) certain other property will produce long-term capital gain if sold at a profit after being held for more than one year.
  • Is real property exempt?  No.  Real property sold at a gain and held for more than one year would be subject to the capital gains tax.  In some situations, a restaurant owner may reside in the same building the restaurant occupies, in which case there would presumably be an allocation of sale proceeds and capital gain between the two elements, since both federal tax law and this bill would exempt a portion of gain from the sale of a personal residence.
  • Sale of equipment?  The bill appears to provide an exception for gains realized from the sale of depreciable property.
  • Is there a “de minimis” exemption?  The bill would tax only the aggregate capital gain in excess of $25,000 per year, or $50,000 for a married couple filing a joint return.
  • What about the sale of a successful restaurant concept?  If a successful restaurant concept has been held for more than one year, gain from its sale would generally represent long-term capital gain, and would thus be taxed under the bill.
  • What if a partner is “bought out”?  Any long-term capital gain realized by a “bought out” partner in a restaurant would be taxed.
  • If someone built their business from the ground up, then sold their business, how would that transaction be handled?  Long-term capital gain from the sale of the business would be subject to the tax.
  • Would it impact transactions when businesses are passed down to other family members?  A gratuitous (i.e., gift) transfer of a business to a family member would normally NOT result in capital gain to the transferor; however, the recipient may later realize a capital gain upon a subsequent sale of the business.
  • When would this new tax take effect?  The new capital gains tax would be imposed upon transactions beginning January 1, 2016.