Selling a business is not just a legal or financial transaction; it is also a tax event. Understanding the tax implications before you sell can help you avoid surprises and potentially save you a significant amount of money. In today’s post, I’ll answer the most common tax questions that I hear from small business owners who are thinking of selling their business. 

What taxes do you pay when you sell a small business?

When you sell a business, how the sale is structured and what exactly is being sold will determine which taxes you owe. 

Most of the time, profits from selling a business are taxed as capital gains, which are typically taxed at lower rates than ordinary income. However, not every part of the sale qualifies for capital gains treatment. 

For example, these different parts of the sale may be taxed differently:

• Inventory is usually taxed as ordinary income.
• Equipment may also be taxed as ordinary income if its sale triggers depreciation recapture.
• The sale of the overall business’ value (aka goodwill) is typically taxed as a long-term capital gain.

Because of the different ways the parts of the business can be taxed, the final tax bill after a business sells depends on how the sale is structured and how the purchase price is allocated among the assets of the business. This is why tax planning before the sale is extremely important.

What is capital gains tax when selling a business?

Capital gains tax applies to profits from selling assets that have increased in value over time.

If you’ve owned your business for more than 1 year, then your profit (gain) from selling certain parts of your business may qualify for long-term capital gains rates. Since that rate is generally lower than ordinary income tax rates, this is what you want. 

Similar to income tax, the rate you’ll pay for long-term capital gains depends on your total taxable income and your filing status. For instance, for 2026, the long-term capital gains tax rates are 0%, 15%, or 20%. The vast majority of small business owners are likely to pay the 15% rate.

What is goodwill when selling a business?

When it comes to selling a business, the term “goodwill” means the amount a buyer will pay for the intangible value of your business. In other words, goodwill refers to the business’ ability to generate future income based on:

• Brand recognition
• Customer or client list
• Experienced staff
• Intellectual property
• Internet domain names
• Licensing agreements
• Proprietary technology or patents
• Reputation
• Service contracts
• Trade secrets (think secret recipe)
• Trademarks or copyrights

Goodwill is typically taxed as a long-term capital gain.

What is the difference between an asset sale and a stock sale?

One of the biggest decisions you’ll need to make when selling your business is whether the transaction will be structured as an asset sale or a stock sale. What you decide here could greatly impact how much you pay in taxes.

Asset Sale

In an asset sale, the buyer purchases individual assets of the business, such as:

• Customer lists
• Equipment
• Goodwill 
• Inventory
• Intellectual property

Buyers often prefer asset sales because they can step up the tax basis of the assets they purchase and then depreciate them again, so this saves them tax money. 

However, asset sales can lead to a higher tax bill for the seller because large portions of the sale price can be allocated to items that will be taxed as ordinary income instead of long-term capital gains.

Stock Sale

On the other hand, in a stock sale, the buyer purchases the owner’s shares of the company instead of individual assets. This structure is common when the business is an S-Corporation or C-Corporation.

This type of sale structure can be more beneficial to the seller because the entire gain is often taxed as a capital gain and there may be fewer tax layers to consider. 

However, buyers often resist stock purchases because they also have to assume any potential liabilities the company may have.

How does an installment sale work when selling a business?

In addition to deciding between an asset sale and a stock sale, there is also a question of timing to consider. One way to use timing to your advantage as a seller is through an installment sale. 

The idea here is that you allow the buyer to pay the full sale price through yearly installments, which allows you to spread the capital gains tax you owe across multiple years as well.

An installment sale offers several advantages:

• Receiving the money over time may keep you from jumping into a higher tax bracket, which can lower your taxes in a single year.
• Instead of one large payment, you can choose to receive predictable income over time.
• Installment agreements typically include interest, which becomes additional taxable income.

It is important to keep in mind that an installment sale also comes with risks. Obviously, if the buyer stops making payments, you may have to seek legal action (with added legal costs) and then you’re back to where you started.

What is purchase price allocation and why does it matter?

When a business is sold through an asset sale, the purchase price must be allocated among the different assets being sold. This allocation is what determines how each portion is taxed.

Common categories used during purchase price allocation are:

• Equipment
• Furniture and fixtures
• Goodwill
• Inventory
• Non-compete agreements

For instance, the allocation for an $800,000 business sale might look like this:

• Equipment: $200,000
• Goodwill: $500,000
• Inventory: $100,000

In this example, inventory and some equipment gains could be taxed as ordinary income, while goodwill might be taxed as a capital gain, so you can see why the allocation process greatly impacts the seller’s final tax bill.

It’s important to remember that for an asset sale, both the buyer and the seller must file Form 8594 to report the allocations to the IRS, and those forms must match.

Are there any tax strategies that can reduce taxes when selling a business?

Yes, there are several tax-saving strategies you can use to reduce your tax bill if you’re selling your business. The most common are:

• Plan the sale for a year when your income is lower so you can reduce your overall tax rate.
• Find a buyer who is willing to make installment payments for several years to help manage your tax bracket and final tax bill.
• Large sales can also sometimes be structured so that the income can flow into a retirement account, which is another way to reduce your taxable income.

What should small business owners do before selling their business?

Many business owners know years ahead of time that they will be selling their business. If this is the case for you, then you have an important opportunity to start discussing restructure or selling structures with your accountant and potential buyers. 

Planning early can make a significant difference in the final amount that ends up in your pocket once you sell your business.

Here’s are some important things you can do before selling your business:

• Review your financial records and make sure you have clean and accurate financial statements to help increase buyer confidence (and possibly the selling price).
• Understand your tax basis so that you can also get a clearer picture of your taxable gain from the sale.
• Determine which type of sale structure would be best for your situation (asset or stock).
• Consult with a CPA before negotiations start. When it comes to maximizing your income, a CPA can help make sure all of your ducks are in a row.

Abridged by Amy

Selling your small business might be one of the largest financial transactions you’ll ever experience. Naturally, you want to focus on the sale price, but make sure you’re not overlooking the tax consequences that come from the way you structure and time the sale.

Understanding capital gains tax, asset versus stock sale structures, installment payments, and purchase price allocation is the first step in making sure that you keep more of the value you worked so hard to build. 

Working with a  CPA to help you before, during, and after the sale can mean the difference of tens or even hundreds of thousands of dollars in taxes saved. A CPA can also help you structure the deal in a way that protects both your financial future and the legacy of the business you worked so hard to build.