Tax Implications of Selling Your Business: What Owners Need to Know

One of the biggest surprises for business owners selling for the first time is the tax bill. After years of building your business, the government takes a significant cut of your proceeds — and the exact amount depends heavily on how the deal is structured.

This isn't tax advice (talk to your CPA), but here's what every business owner should understand before going to market.

Capital Gains: The Basics

When you sell your business, the profit is generally taxed as a capital gain. If you've owned the business for more than one year, you qualify for long-term capital gains rates, which are more favorable than ordinary income rates.

2025-2026 federal long-term capital gains rates:

• 0% for taxable income up to ~$47K (single) / ~$94K (married filing jointly)
• 15% for most sellers
• 20% for taxable income above ~$518K (single) / ~$583K (married filing jointly)

On top of that, high earners pay a 3.8% Net Investment Income Tax (NIIT), bringing the effective top federal rate to 23.8%.

California state tax: California taxes capital gains as ordinary income — with a top rate of 13.3%. Combined with federal taxes, California business sellers can face a total effective tax rate of 35-37% on their gains.

Asset Sale vs. Stock Sale: Why It Matters

The structure of your deal has major tax implications.

Asset Sale

In an asset sale, the buyer purchases individual assets — equipment, inventory, customer lists, goodwill, etc. Each asset category is taxed differently:

• Inventory and accounts receivable: Taxed as ordinary income
• Equipment and tangible assets: Subject to depreciation recapture (ordinary income) up to the amount previously depreciated, then capital gains on any excess
• Goodwill and intangible assets: Taxed at long-term capital gains rates

Most small and mid-market deals are asset sales. Buyers prefer them because they get a stepped-up basis — allowing them to depreciate the purchased assets again. This saves the buyer money over time, which is why buyers push for asset structures.

The downside for sellers: the allocation of purchase price across asset categories matters enormously. If more of the price is allocated to inventory or depreciation recapture assets, you pay more in ordinary income tax. Negotiating the purchase price allocation is a critical part of any asset sale.

Stock Sale (or Equity Sale)

In a stock/equity sale, the buyer purchases your ownership interest in the entity. For the seller, this is simpler — the entire gain is typically taxed at long-term capital gains rates.

Sellers prefer stock sales for this reason. Buyers generally don't, because they inherit the entity's historical liabilities and don't get a stepped-up basis.

Section 338(h)(10) election: In some cases, a stock sale can be treated as an asset sale for tax purposes, giving the buyer the depreciation benefits while maintaining the legal simplicity of a stock transfer. This is worth discussing with your tax advisor if you're selling a C-corporation.

C-Corp vs. S-Corp vs. LLC: Entity Structure Matters

C-Corporation

C-corps face double taxation on asset sales: the corporation pays tax on the gain at the corporate level (21% federal), and then the shareholder pays tax again when the proceeds are distributed as dividends or liquidation proceeds. This can result in combined effective rates of 40%+ for California sellers.

If you're a C-corp, a stock sale or a 338(h)(10) election may save significant taxes. Planning ahead — potentially converting to an S-corp — can also help, though the 5-year built-in gains period applies.

S-Corporation

S-corps are pass-through entities — gains flow through to the shareholders' personal returns and are taxed once. This eliminates the double taxation problem and is one reason S-corps are the most common structure for small and mid-market businesses.

LLC (Taxed as Partnership)

LLCs taxed as partnerships also benefit from pass-through treatment. Gains flow to the members based on their ownership percentages and are taxed at their individual rates.

Tax Strategies to Consider

Installment Sale

If the buyer pays you over time (seller financing or earnout), you may be able to use the installment sale method to spread the gain over multiple tax years. This can keep you in lower tax brackets and defer the tax hit.

Qualified Small Business Stock (QUBS) Exclusion

If your business is a C-corp and you've held the stock for 5+ years, you may qualify to exclude up to $10M (or 10x your basis) of capital gains under IRC Section 1202. The requirements are specific — your business must have had gross assets under $50M when the stock was issued, among other criteria — but if you qualify, the tax savings are enormous.

Opportunity Zone Reinvestment

Reinvesting capital gains into a Qualified Opportunity Zone Fund within 180 days of the sale can defer and partially reduce your capital gains tax. The deferral runs until 2026 (or earlier sale of the OZ investment), and gains on the OZ investment itself may be tax-free if held for 10+ years.

Charitable Strategies

If you have philanthropic goals, donating appreciated stock or business interests to a Charitable Remainder Trust (CRT) or Donor-Advised Fund (DAF) before the sale can provide income tax deductions and defer or eliminate capital gains taxes on the donated portion.

State Tax Planning

California's 13.3% capital gains rate is the highest in the nation. Some business owners consider establishing residency in a no-income-tax state (Nevada, Texas, Florida, etc.) before selling. However, California's Franchise Tax Board aggressively audits these situations. The residency change must be genuine, well-documented, and typically established at least 18 months before the sale to withstand scrutiny.

The Allocation Negotiation

In an asset sale, the IRS requires both buyer and seller to file Form 8594, reporting how the purchase price is allocated across seven asset categories. Both parties must use the same allocation.

This creates a natural tension: sellers want more allocated to goodwill (capital gains rates), while buyers want more allocated to tangible assets and non-competes (which they can depreciate/amortize faster).

The allocation negotiation can shift hundreds of thousands of dollars in tax liability. Don't leave this to the lawyers and accountants at closing — it should be addressed in the letter of intent.

Start Planning Early

Tax planning shouldn't start when you have a signed LOI — it should start 2-3 years before you go to market. Entity restructuring, installment sale planning, QSBS qualification, and residency changes all require lead time.

I always recommend my clients involve their CPA and estate planning attorney early in the process. If you're thinking about selling and want to understand how deal structure affects your after-tax proceeds, let's talk.