Tax Planning for Sale of a Closely Held Business

Why tax planning matters before you sell

Selling a closely held business is often the single largest taxable event an owner experiences. Taxes can materially reduce the cash you ultimately receive, and the way you structure the deal affects both the buyer’s willingness to pay and the seller’s tax bill. In my practice I’ve seen owners lose hundreds of thousands of dollars—or preserve similar amounts—based largely on timing and structure decisions made well before signing documents.

This guide lays out the practical tax issues to evaluate, reliable sources to consult, and actionable steps you can take to protect value and limit surprises.

Major tax issues to evaluate

• Capital gains vs. ordinary income. Most sales produce capital gains on the sale of equity or capital assets. Long-term capital gains (assets held more than one year) are taxed at preferential federal rates (0%, 15%, or 20%) depending on taxable income; high-income sellers may also face the 3.8% Net Investment Income Tax (NIIT) (see IRS guidance on NIIT: https://www.irs.gov/businesses/small-businesses-self-employed/net-investment-income-tax).
• Depreciation recapture. If the sale includes business tangible property that you claimed depreciation on, some or all of that gain may be taxed as ordinary income under Sections 1245/1250 rules (depreciable personal property vs. real property rules). This often increases the effective tax rate on part of the sale proceeds.
• Entity and transaction type differences. The tax impact depends on whether the deal is an asset sale, stock (or membership interest) sale, or a hybrid.
• Buyers typically prefer asset purchases because they can step up the tax basis of the acquired assets, creating future depreciation deductions.
• Sellers usually prefer stock sales because they often produce capital gains taxed at lower rates and avoid double taxation for corporate sellers.
• Partnership and LLC interest sales. Selling a partnership or LLC interest can trigger ordinary income treatment for “unrealized receivables” or “inventory items” (IRC §751), which creates a mix of ordinary and capital gain.
• State and local taxes. State income tax rates, corporate taxes, and transfer taxes can change the net outcome by tens of percent depending on where the business is located.

Authoritative starting points: IRS, “Selling Your Business” (https://www.irs.gov/businesses/small-businesses-self-employed/selling-your-business) and IRS materials on like-kind exchanges (1031) and installment sales.

Common transaction-level strategies

• Asset sale vs. stock sale: evaluate buyer demand, tax allocation, and purchase price adjustments. Buyers want asset purchases (basis step-up); sellers often prefer stock sale (capital gain treatment). Negotiation frequently splits the difference via price and post-closing tax indemnities.

• Allocation of purchase price: in an asset sale, the purchase agreement should include a Section 1060 allocation that reflects fair market value across asset classes (goodwill, equipment, real estate). This allocation determines character and timing of tax recognition for both parties.

• Installment sales (IRC §453): spreading payments across tax years can sometimes lower immediate tax exposure by shifting portions of gain into later years when the seller may be in a lower tax bracket. Installment treatment has tax-computation rules and interacts with interest, contingent payments, and depreciation recapture; consult a CPA and see IRS guidance on installment sales (Pub. 537/Topic guidance).

• Qualified Opportunity Funds (QOFs): investing capital gains in a QOF within the allowed window can defer gain recognition and, in some circumstances, reduce taxable gain if the investment is held long enough (see IRS Opportunity Zones FAQ: https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions). QOFs are complex and require timely action and documentation.

• Qualified Small Business Stock (Section 1202): for C corporations meeting strict criteria, gains on QSBS held more than five years may qualify for partial or full exclusion (subject to limits). This is a powerful exception but is only available in narrow situations—confirm eligibility early.

• Like-kind exchanges (IRC §1031): after 2018, §1031 deferral is generally limited to real property only; personal property swaps do not qualify. If your transaction includes real estate that can be exchanged, this remains a possible strategy.

• Earn-outs and contingent payments: structuring part of the purchase as contingent on future results can allocate risk and may change timing and character of taxable income for the seller.

• Employee and owner compensation timing: withholding, deferred compensation, and closing-date payroll issues can affect amounts withheld and taxable income in the year of sale.

Operational and documentation steps to take (practical checklist)

1. Start 12–24 months early. Early planning expands options and helps avoid rushed compromises.
2. Assemble your team: CPA (tax), M&A attorney, business valuation expert, and financial planner who understands post-sale liquidity and retirement planning.
3. Run tax projections under multiple deal scenarios: asset sale vs. stock sale, immediate sale vs. installment, and with/without QOF reinvestment.
4. Clean up records and basis calculations: ensure accurate tax basis documentation for shareholders or partners—basis errors can be costly.
5. Identify hot assets and recapture risk: inventory, accounts receivable, and depreciable property often generate ordinary income on sale—model these explicitly.
6. Consider entity changes if time permits: while conversions solely for tax reasons can trigger adverse rules, sometimes reorganizing ownership or capitalization well in advance can create opportunities (consult counsel).
7. Coordinate with buyer on purchase agreement tax allocation (Section 1060) and escrow/indemnity terms.
8. Plan for state tax and sales/transfer taxes; some states tax the sale as income, others impose transfer taxes on real estate or goodwill.

Practical examples and cautions from practice

• Example: an owner negotiated a stock sale to receive capital-gain treatment, but the buyer insisted on an asset sale for a basis step-up. A middle ground was a higher purchase price with a tax indemnity and a holdback escrow to address later adjustments—this preserved most of the seller’s after-tax proceeds while satisfying the buyer’s need for asset basis.

• Caution: like-kind exchanges are frequently misunderstood. Since 2018, non-real estate swaps don’t qualify. Trying to force an ineligible exchange can trigger audits and penalties.

• Caution: Qualified Opportunity Fund benefits require strict timelines (generally 180 days from recognition event) and documentation. Don’t assume the deferral is automatic—timely investment and compliance are required.

When to consider post-sale tax planning

Even after closing, you may have choices that affect tax bills: how you invest proceeds, whether to elect installment sale reporting, and whether to make gifts or charitable donations to offset gain. Coordinate your personal tax planning with the business sale timeline.

If you expect difficulty paying the resulting tax bill, the IRS offers options such as installment agreements for tax payments; see our article on qualifying for an IRS installment agreement for tips on eligibility and documentation: Qualifying for an IRS Installment Agreement: Eligibility, Costs, and Application Tips.

Also review the operational tax steps described in our broader checklist: Tax Steps When Selling a Business: From Valuation to Reporting.

Key questions to ask your advisors

• Will the buyer accept a stock sale? If not, can price and indemnities close the gap?
• Which portion of the sale will be ordinary income because of depreciation recapture or §751 hot assets?
• Do I qualify for Section 1202 QSBS treatment or for any state-level exemptions?
• Can the transaction be structured as an installment sale or involve a QOF reinvestment to defer or reduce gain?
• What is the exposure to the NIIT and state income taxes, and how will timing affect my marginal rates?

Final notes and next steps

Every sale is unique. The best outcome combines realistic buyer expectations, clear documentation, and tax-aware negotiation. Start planning early, get specialized advisors involved, and run side-by-side tax projections for competing deal structures.

This article is educational and not individualized tax advice. For a plan tailored to your facts, consult a CPA and an M&A attorney. Authoritative resources you can read now include the IRS Selling Your Business guidance (https://www.irs.gov/businesses/small-businesses-self-employed/selling-your-business), IRS Opportunity Zones information (https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions), and IRS pages on 1031 exchanges and the Net Investment Income Tax.

Professional disclaimer: This content is for educational purposes only and does not substitute for professional tax, legal, or financial advice. Consult a qualified tax advisor for recommendations specific to your circumstances.