Understanding The Tax Implications Of Selling Your Business

How Are You Taxed When Selling a Business?

In a business sale, the tax implications are driven by the classification of the sale as either an asset or a stock sale, and whether the business is a pass-through entity (LLC, S Corporation, partnership) or a C Corporation, which could be subject to double taxation if structured as an asset sale.

Asset Sale

An asset sale offers significant benefits for the buyer. The buyer can depreciate the company’s assets immediately and pick and choose which assets and liabilities to assume. Itemizing the assets to purchase adds to the complexity, time, and cost of getting a deal done. Importantly, for exiting business owners, an asset sale often results in a larger tax bill. This includes the loss of a special tax benefit called qualified small business stock, or QSBS.

If eligible, QSBS can shield business owners from paying tax on gains up to $10M (or $15M for future exits where stock was acquired after July 4, 2025). However — among other requirements — eligibility requires the sale to be structured as a stock sale.

In an asset sale, every asset purchased by the buyer will have unique tax treatment depending on the nature of the asset. Tangible assets, like equipment and vehicles, are usually taxable as regular income. The exact gain will depend on the asset’s tax basis. The top federal tax rate is 37% on ordinary income versus a maximum 20% rate for long-term capital gains. Intangible assets, like intellectual property, may receive more favorable long-term capital gains tax treatment.

Stock Sale

Entrepreneurs seeking to maximize the proceeds from selling their business should prefer a stock sale over an asset sale. In a stock sale, the gain will be taxed as a long-term capital gain (unless they purchased the business less than a year ago). Federal long-term capital gains tax rates are 15% to 20%. Unlike in an asset sale, the buyer assumes all corporate liabilities, and QSBS eligibility is preserved.

Entity Type

The tax implications of selling your business also depend on the structure of the business. Most businesses are set up as pass-through entities. This means any tax implications flow down to the individual business owners on their personal tax returns. In contrast, owners of C Corporations may be subject to double taxation when selling their business.

In an asset sale, the C Corporation pays tax at the corporate level, which currently carries a 21% tax rate. The after-tax proceeds then flow to the shareholders, who pay tax again (typically at capital gains tax rates) on their tax returns. Note that a stock sale involving a C Corporation isn’t subject to double taxation. Instead, the gain would be taxable to the individual shareholders, much like a stock sale involving a pass-through entity.

State Taxes

In addition to federal tax, business owners must also navigate state tax implications when selling a business. While the nature of the gain generally aligns with federal tax treatment, each state has its own tax laws and rates. For example, California does not have a preferential rate for long-term capital gains, and Massachusetts imposes a millionaires’ surtax of 4% on all taxable income greater than $1M (in 2023 and indexed for inflation thereafter).

Businesses operating in multiple states should consult state tax specialists to understand the impact. And as you consider tax planning opportunities before selling the company, understand that relocating to another state doesn’t always mean the gain from the sale will be subject to your new state’s tax laws. Businesses with a physical footprint must typically source any gains from a sale to that state.

Strategic Tax Planning For The Sale Of Your Business

Depending on your goals, tax situation, liquidity needs, and other factors, you may have some opportunities to reduce tax on the sale of your business with proper planning. Here are several strategies to consider discussing with your team of tax, legal, and financial advisors experienced with founder liquidity events.

• Consider an F reorganization to restructure the business and provide tax benefits to both buyers and sellers, rather than favoring just one party.
• Gifting qualified small business stock (QSBS) to children in trusts to maximize the tax-free treatment in a stock sale. Before making an irrevocable gift to family, always work with your financial advisor to ensure you can sustain your lifestyle without that portion of the proceeds.
• Sellers should strongly consider asking for a gross-up for taxes as part of negotiations in an asset sale. Essentially, tax advisors calculate the sellers’ tax liability under a stock sale and an asset sale, and the buyer pays the seller the difference. This underscores just how advantageous an asset sale structure is for the buyer.
• Consider the pros and cons of rollover equity. Rollover equity is common in private equity deals; sellers often have the opportunity — or requirement — to roll a portion of their proceeds into equity in the acquiring business. Rollover equity can be taxable or tax-free. A host of considerations apply: liquidity needs, buyer fit, lack of control, etc., but it can also offer tax deferral and another bite at the apple.
• Installment sales, including seller-financed notes, also allow sellers to avoid a significant tax liability in the year of the sale by spreading the recognition of the gain over the term of the loan. Again, consider liquidity needs, lifestyle goals, opportunity cost, and the risk that the buyer may be unable to service the debt.
• Consider building carryover capital losses in a taxable investment account with direct indexing. Accumulated losses can offset capital gains in a stock sale.
• If charitably inclined, consider making a large, one-time donation through a donor-advised fund in the year of sale. Although actual distributions to charities can go out over years, the full value of the gift (which can be made with sale proceeds) is deductible in the year it’s made, subject to regular limits.

Next Steps And Post-Exit Planning

Selling a business is like having another full-time job while running the company. And you have to do both jobs well: if your metrics fall, it can affect the valuation, but if you spend too much time working in the business, time could kill the deal. Planning well ahead of the sale and hiring a team of advisors to help with the exit are key.

Once the deal is done, you’ll need to make some important decisions about what to do with the sale proceeds. Sudden wealth from a business sale requires careful wealth planning to ensure you can enjoy your lifestyle and potentially build generational wealth.

Common mistakes after liquidity events include spending money too quickly, staying in cash, failing to coordinate with your legal, tax, and financial advisors, not accounting for taxes in financial projections, and neglecting to align your estate plan with your new financial situation. Integrating the post-exit tax implications from the sale of your business with your long-term financial plans is a strong starting point.