Quick overview

Selling a business is more than negotiating a price. Tax rules shape how much of the sales proceeds you keep and when you pay. The three high‑impact areas are timing (long‑ vs. short‑term gain), entity and transaction type (stock sale vs. asset sale, C vs. S corp, LLC), and the use of installment sales to spread tax liability. Below I outline how each area affects tax treatment, practical steps, and reporting requirements. In my 15 years advising business owners, a few targeted decisions—done well before signing the purchase agreement—regularly save clients tens or hundreds of thousands of dollars.

Asset sale vs. stock sale: why the form of the deal matters

  • Asset sale: Buyers usually prefer asset purchases because they can step up basis in assets and take additional depreciation. Sellers receive allocations among classes of assets (goodwill, inventory, equipment) under IRC section 1060 and report the sale on Form 8594. For sellers, portions of the sale may be ordinary income (depreciation recapture) and portions capital gain (goodwill).
  • Stock sale: Easier for sellers of C or S corporations because proceeds generally flow to shareholders as capital gains. For buyers this means fewer basis-step adjustments in the business assets.

Tax impact: Asset sales typically produce a mix of ordinary income (e.g., Section 1245 recapture on equipment) and capital gain (goodwill). Stock sales often produce capital gain for shareholders, which is usually taxed at long‑term capital gains rates if the stock was held >1 year.

Key internal link: for issues that can arise when a sale generates a tax bill you can’t pay immediately, consider IRS payment options such as an installment agreement. See our guide to IRS installment plans for practical enrollment tips.

Timing: short‑term vs. long‑term capital gains and year selection

  • Long‑term capital gains: Holding an asset (or stock) more than one year qualifies the gain for long‑term capital gains rates, which are typically lower than ordinary income rates. For many sellers the top federal long‑term capital gains rate is 20% (plus potential 3.8% net investment income tax) while ordinary income rates can reach 37% at the federal level.
  • Timing the closing date and accelerating/delaying receipt of payment can change whether a sale is reported in one tax year or another; that may matter for where you fall in tax brackets or for the application of the net investment income tax (NIIT).

Practical note: sellers sometimes shift the closing date into the next tax year, split payments, or negotiate an earn‑out to manage recognition. In my practice, I’ve seen a well‑timed closing reduce a seller’s effective federal tax cost substantially. Always coordinate timing moves with your CPA to avoid unintended consequences (e.g., state tax year rules).

Entity‑specific traps and opportunities

  • C corporations: The classic double‑tax problem—corporate level tax on sale of assets, then shareholder tax when proceeds are distributed—can materially reduce net proceeds. There are planning options (asset vs. stock sale, qualified stock sale rules) but they are complex.
  • S corporations and LLCs taxed as pass‑throughs: Gains typically flow through to owners’ personal returns and are taxed once (subject to built‑in gains rules when a former C corp converts to S). S corporations that previously were C corps may be subject to the built‑in gains tax (BIG) on appreciated assets sold during the recognition period. See IRS guidance on the built‑in gains tax for details.
  • Partnerships and LLCs: Allocation of sales proceeds among partners, and partnership tax basis and built‑in gain rules, require accurate K‑1s and careful drafting of the purchase agreement.

Tip: consider entity conversion timing well before a planned sale. Converting a C corporation to S right before a sale can trigger the built‑in gains tax; conversely, converting too late may foreclose other opportunities.

Installment sales: how they work and when they help

  • Basic rule: Under IRC section 453, the installment method lets a seller report gain as payments are received, which spreads tax liability over multiple years. Use Form 6252 (Installment Sale Income) to report the transaction.
  • What you can defer: Most capital gain is reportable on the installment method, but important exceptions exist. Depreciation recapture (generally Section 1245 and 1250 recapture) is usually recognized in the year of sale and cannot be deferred through the installment method in many cases. Additionally, sales to related parties have special rules that may restrict use of the installment method.
  • Interest: Installment sales often include stated interest or imputed interest rules (to avoid below‑market financing). Make sure the promissory note includes a commercially reasonable interest rate or understand the imputed interest rules and potential substitution of interest for capital gain.

Reporting: Report the installment sale with Form 6252. If payments are later sold or the debt is collected early, special recapture/recognition rules apply. For more on practical payment planning and how to estimate payments, see our guide on calculating realistic monthly payments for installment obligations.

Depreciation recapture and ordinary income components

When a sale includes depreciated assets, a portion of the gain can be taxed as ordinary income due to depreciation recapture (Section 1245 for personal property; Section 1250 for real property). This recapture often must be reported in full in the year of the sale even if other gain is reported on the installment method. Work with your accountant to segregate ordinary and capital elements in the purchase agreement allocation (Form 8594 helps document the allocation).

Purchase price allocation and Form 8594

Purchase agreements typically allocate the sale price across asset classes (inventory, tangible equipment, intangible assets like goodwill). These allocations determine which portion is ordinary and which is capital gain. The buyer and seller each file Form 8594 to report the allocation under IRC section 1060; mismatches invite IRS attention.

Practical tip: negotiate the allocation explicitly in the purchase agreement—and if you are the seller, identify goodwill or other Section 197 intangibles that qualify for capital gain treatment.

Special tax provisions to check

  • Qualified Small Business Stock (QSBS, IRC section 1202): If the business qualifies, a sale of QSBS may permit exclusion of gain (subject to limits and specific holding period rules). Confirm eligibility early—QSBS rules are technical.
  • Built‑in gains tax for S corporations: If a C corporation converts to an S, sales of previously recognized built‑in gain items during the recognition period may be subject to tax at the corporate level.
  • Net Investment Income Tax (NIIT): An extra 3.8% may apply to net investment income (including capital gains) above certain AGI thresholds. Plan sale timing and installment receipts with NIIT thresholds in mind. See the IRS NIIT overview for thresholds and rules.

State and local taxes

State tax treatment varies widely: some states tax capital gains as ordinary income, others offer different exclusions for small business sales. Also consider sales‑use tax, local transfer taxes, and nexus issues for multistate businesses. Engage a state tax specialist if you operate in multiple states.

Common mistakes I see

  • Waiting too late to plan entity and allocation issues.
  • Relying solely on the buyer for price allocation without documenting your position.
  • Choosing installment sales without analyzing recapture and interest consequences.
  • Failing to consider NIIT and state taxes when projecting net proceeds.

Practical checklist before you sign

  1. Decide whether you will prefer an asset sale or stock sale; calculate net‑of‑tax proceeds under both structures.
  2. Have a CPA model after‑tax proceeds under alternative timing and payment structures (lump sum vs. installment).
  3. Confirm depreciation schedules and quantify recapture exposure.
  4. Negotiate purchase price allocation expressly in the purchase agreement and file Form 8594 correctly.
  5. If using an installment sale, prepare a promissory note with appropriate interest and know Form 6252 reporting obligations.
  6. Check QSBS eligibility, built‑in gains exposure, and NIIT thresholds.
  7. Coordinate state tax planning.

Example (simplified)

Seller sells a business for $2,000,000 in an asset sale. Allocation: $1,200,000 goodwill (capital gain), $600,000 equipment (basis $200,000 — $400,000 gain subject to recapture), $200,000 inventory (ordinary). If seller uses installment method and receives payments over five years, the goodwill portion can be recognized as payments are received. The $400,000 depreciation recapture on equipment will usually be recognized in the year of sale as ordinary income.

Reporting forms and authoritative resources

Internal resources on FinHelp:

  • If a sale creates a tax bill you need to pay over time, see our guide to IRS installment plans for types, costs, and enrollment tips. (Internal: IRS Installment Agreements: Types, Costs, and Application Tips)
  • Practical help in estimating periodic payment obligations and cash flow when you receive proceeds over time: How to calculate a realistic monthly payment for an installment obligation (Internal: How to Calculate a Realistic Monthly Payment for an Installment Agreement)

Professional disclaimer

This article is educational and does not replace personalized tax advice. Tax law is complex and subject to change; coordinate any sale plan with a qualified CPA, tax attorney, or financial advisor who can review contracts, model after‑tax outcomes, and advise on state rules.

Final thought

Tax planning is not an afterthought in a business sale—it’s a core element of deal structure. Early coordination among your tax advisor, legal counsel, and broker increases the chance you’ll keep more of the proceeds and avoid surprises at tax time.