Tax on Selling a Business: What Sellers Actually Owe

Most sellers spend years building their business and about two weeks thinking about taxes before they sell.

That is backwards. And it is expensive.

The tax bill on a business sale can run anywhere from 15% to 37% of your proceeds, depending on how the deal is structured. On a $1.5M sale, the difference between a well-structured deal and a poorly structured one can mean $150,000 to $300,000 in additional taxes owed. That is not a rounding error. That is a house. Understanding how the tax on selling a business works before you sign an LOI is one of the most important conversations you will have during the entire process. Not after the LOI. Not during diligence. Before any of it.

Here is what actually happens to your money after the wire clears.

Why Deal Structure Determines Your Tax Bill

The single biggest variable in your tax outcome is not your sale price. It is how the deal is structured.

There are two primary structures: asset sales and stock sales. Most small business acquisitions, especially those financed through SBA 7(a) loans, go through as asset sales. That distinction matters because the two structures are taxed in fundamentally different ways, and the one buyers prefer is almost never the one that benefits you most.

In an asset sale, the buyer acquires individual assets of the business. Equipment, inventory, customer lists, goodwill. Each asset class gets allocated a portion of the purchase price, and each class is taxed at a different rate. Some at capital gains. Some at ordinary income. The allocation determines where your money goes after the IRS takes its cut.

In a stock sale, the buyer acquires your ownership shares directly. You pay capital gains tax on the difference between your basis in the stock and the sale price. That is usually a cleaner, lower-tax outcome for sellers.

But here is the problem. Buyers strongly dislike stock sales. They inherit all liabilities and lose the depreciation benefits that come with stepping up asset values. So most buyers push hard for asset sales, and if SBA financing is involved, the lender will too. Your leverage to negotiate a stock sale depends largely on the business type, deal size, and how much competition exists for your business.

Know this going in. Your CPA should model both structures before you respond to any offer.

How the Asset Allocation Breaks Down

In an asset sale, you and the buyer have to agree on how the purchase price gets allocated across different asset classes. This allocation is reported to the IRS on Form 8594. It is not optional, and it has to match between buyer and seller.

The IRS groups assets into classes. The tax treatment varies significantly:

Tangible assets (equipment, inventory): Taxed at ordinary income rates to the extent of depreciation recapture, then capital gains on any excess. If you bought a piece of equipment for $100,000, depreciated it to $20,000, and allocated $80,000 to it in the sale, $60,000 of that is ordinary income. That can mean 37% on that single line item.
Goodwill and going concern value: Typically taxed at long-term capital gains rates (0%, 15%, or 20% depending on your income). This is the most favorable category for sellers. Every dollar here instead of somewhere else saves you real money.
Covenant not to compete: Taxed as ordinary income. Full rate. Buyers love allocating purchase price here because they get to amortize it over 15 years. You pay ordinary income rates on every dollar.
Customer lists and other intangibles: Taxed at capital gains rates if held longer than one year.

The allocation negotiation matters more than most sellers realize. Every dollar the buyer pushes into a non-compete is a dollar taxed at your highest marginal rate. Every dollar that lands in goodwill is taxed at capital gains rates. Work with your CPA to counter-propose an allocation that minimizes ordinary income exposure. This is not aggressive tax planning. This is basic deal hygiene.

Long-Term vs. Short-Term Capital Gains on a Business Sale

If you have owned your business for more than one year, most of your sale proceeds will qualify for long-term capital gains treatment. The federal rates are 0%, 15%, or 20%, based on your total taxable income for the year.

For most sellers in the $500K to $2M sale range, the 15% or 20% rate applies. But that is not the whole picture.

Add in the 3.8% Net Investment Income Tax (NIIT), which kicks in when your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). A business sale almost always triggers this threshold. So your effective capital gains rate could be 23.8% on the federal side before you even get to state taxes.

And state taxes vary enormously. California adds another 13.3% on top of federal. Texas and Florida add zero. The state you file in for the year of sale matters, and it is a conversation to have with your CPA well before closing, not a surprise you discover in April.

The Installment Sale and Seller Note Tax Treatment

So that covers the basic rate structure. The timing side is a different conversation.

In most SBA-financed deals, you will carry a seller note. The typical structure we see is a 10-year full standby note at 0% interest, covering 5% to 15% of the purchase price. That means you do not receive that portion of your proceeds at closing. It sits.

The installment sale method (IRS Form 6252) allows you to spread the capital gains tax on the seller note portion across the years you actually receive principal payments. Since most standby seller notes do not begin paying until the SBA loan is substantially paid down (which could be the full 10 years), this can create meaningful tax deferral.

There is a catch worth understanding. Interest imputation rules may apply even if your note says 0%. The IRS requires that loans below the Applicable Federal Rate be treated as if they carry interest. Your CPA needs to model how the IRS will view your specific note structure, because the imputed interest creates taxable income even though no cash changed hands.

The short version: installment sale treatment can reduce your tax burden in the year of closing. But the tax does not disappear. It defers.

Depreciation Recapture: The Tax Most Sellers Forget

This one catches sellers off guard more than almost anything else. We have seen it change the after-tax math on deals that looked great on the surface.

If your business has significant depreciated assets (real equipment, vehicles, machinery), you may owe depreciation recapture tax on those assets when you sell. This applies even if the overall sale qualifies for capital gains treatment.

The rule under Section 1245: if you have been depreciating an asset and you sell it for more than its current depreciated book value, the IRS recaptures the depreciation you previously claimed as ordinary income. Up to 37%.

Here is a real-world example. Say you are selling a landscaping company. You have trucks and equipment with a book value of $80,000 that you originally paid $400,000 for over the years. If the buyer allocates $280,000 to equipment in the asset purchase agreement, you have $200,000 in depreciation recapture. Taxed at ordinary income rates. Not capital gains.

That is $74,000 in federal tax on equipment alone, before you look at anything else in the deal.

Model this before accepting an offer. Not after.

How the Tax on Selling a Business Affects Your Net Proceeds

Let us put actual numbers on this.

You are selling a manufacturing business for $2M. After legal fees, your net proceeds before taxes are roughly $1.9M. The buyer allocates $200,000 to equipment (recapture territory), $150,000 to non-compete, $200,000 to accounts receivable, and $1.35M to goodwill. You carry a $200,000 seller note on standby.

Rough federal tax calculation (assuming 20% long-term capital gains rate plus 3.8% NIIT):

Equipment recapture: $200,000 at 37% = $74,000
Non-compete: $150,000 at 37% = $55,500
Goodwill received at close: $1.15M at 23.8% = $273,700
Seller note goodwill (deferred via installment): $200,000 at 23.8%, deferred

Total federal tax on cash received at close: roughly $403,000. That is federal only.

On $1.9M in gross proceeds, you net closer to $1.5M before state taxes. Maybe $1.3M after state, depending on where you live. In California, give or take, you are looking at the lower end of that range.

This is not a reason not to sell. It is a reason to structure the deal carefully and negotiate the allocation before signing anything.

What Sellers Can Do to Reduce Their Tax Exposure

You cannot avoid paying tax on a business sale. But you can plan around it. The difference between planning and not planning is six figures on most deals in this range.

Negotiate the allocation. Push back on non-compete and equipment allocations. Every dollar you move from ordinary income to goodwill saves you the spread between your marginal rate and capital gains rates. On a $500,000 reallocation, that can be $70,000 to $90,000.

Consider installment sale treatment. If your seller note is structured as a standby note with deferred principal, you may qualify to push some of the gain into future tax years. This does not eliminate the liability, but it manages when you pay.

Qualified Small Business Stock (QSBS). If you own C corporation stock that qualifies under Section 1202 (as defined on SBA.gov and in the Internal Revenue Code), up to $10M in gain may be excluded from federal tax entirely. This is a complex area that requires early planning. If you structured as a C corp and have held shares for more than five years, have your attorney and CPA analyze QSBS eligibility well before you close. Not everyone qualifies. But when it applies, it is significant.

Time the closing deliberately. Closing in December versus January shifts the entire tax event to a different tax year. In some cases that means lower rates, more time to plan, or the ability to spread income across two years if you also have installment payments beginning.

Work with your CPA before the LOI, not after. This is the one that matters most. From what we have seen, too many sellers bring in their accountant after the LOI is signed, when the structural decisions are already locked. The time to model the tax implications is before you accept any offer. After the purchase agreement is executed and the allocation is agreed, your options shrink considerably.

Frequently Asked Questions

How much tax do you pay when you sell a business?

It varies by deal structure, asset allocation, and your personal income situation. Most sellers pay a combination of capital gains tax (15% to 23.8% federally, including NIIT) on goodwill and long-term assets, plus ordinary income rates (up to 37%) on depreciation recapture and non-compete payments. State taxes add more. Total effective tax rates on a business sale commonly run 25% to 40% of proceeds, though proper planning can push toward the lower end.

Is selling a business taxed as capital gains or ordinary income?

Both, usually. Goodwill and long-term intangible assets are taxed at capital gains rates. Equipment sold above its depreciated book value triggers recapture at ordinary income rates. Non-compete payments are ordinary income. Most business sales involve a mix of both, which is why the asset allocation in the purchase agreement matters so much. The allocation is where the real tax outcome is determined.

What is a seller note and how is it taxed?

A seller note is a portion of the purchase price that the buyer owes you over time rather than paying at closing. In SBA-financed deals, these are typically structured on a 10-year full standby basis. Using the installment sale method (Form 6252), you can defer capital gains tax on the note until you actually receive principal payments. The deferred amount is taxed as principal comes in, which may lower your total tax in the year of the sale.

Do you pay self-employment tax when you sell a business?

Generally, no. If structured as a capital asset sale, the proceeds are not subject to self-employment tax. However, if any portion of the sale price is allocated to personal goodwill, services, or a consulting agreement rather than the business itself, that portion may be treated as ordinary income subject to SE tax. Your CPA should review the final allocation carefully.

When should I talk to a CPA about selling my business?

Before you accept an offer or sign a letter of intent. The asset allocation, deal structure, and installment sale elections all need to be modeled before you commit to terms. Many sellers bring their accountant in too late. Once the purchase agreement is signed and the allocation is agreed, the tax-saving options are limited.

Talking to a Serious Buyer Before You Start

Understanding the tax on selling a business is step one. Step two is making sure the buyer across the table is worth your time.

Regalis Capital works with serious, pre-qualified buyers who use SBA 7(a) financing to acquire businesses like yours. Our buyers come to the table with their financing structured and their advisory team already in place. Deals move efficiently and close at a high rate.

There is no cost to you as the seller. No commissions. No fees. No obligation.

If you want to connect with a well-funded, properly advised buyer, start the conversation here.