Selling part of your business: tax planning before an exit

What decides the tax when you sell part of a business?

Four things: what is being sold, how the price is allocated, when the money arrives, and where you live and where the business operates. Each one can change the total tax bill substantially, and each is set mostly by the deal documents.

Selling part of a business can mean selling shares or a membership interest to a partner, an investor or a key employee, or selling some assets or a division. The same price can produce very different after-tax results depending on the structure.

Is it better to sell stock or assets?

Sellers usually prefer selling stock or an ownership interest, because the gain is more likely to be capital gain. Buyers often prefer buying assets, because they get a fresh basis to depreciate. The final structure is a negotiation, and the price should reflect it.

For partnerships and LLCs taxed as partnerships, the sale of an interest can still produce ordinary income for the share tied to receivables, inventory and depreciation recapture. S corporation stock sales generally produce capital gain, but the entity type still shapes the options.

Which parts of a sale are taxed as ordinary income?

Depreciation recapture on equipment and vehicles, inventory, receivables of a cash basis business, and payments for your future services, such as consulting agreements or some earnouts tied to your work, are generally taxed as ordinary income.

That is why the purchase price allocation matters. Goodwill held for more than a year is generally capital gain to the seller. A non-compete payment is ordinary income. Buyers and sellers have opposite incentives here, so the allocation should be negotiated, written into the agreement and reported consistently.

Per IRS Rev. Proc. 2025-32, for 2026 the 15 percent long-term capital gain rate applies up to $613,700 of taxable income for joint filers ($545,500 single), and 20 percent above that. The 3.8 percent net investment income tax can also apply above $250,000 of modified AGI for joint filers ($200,000 single), per IRS Topic 559. Owners who materially participate in the business may avoid it on part of the gain.

How does an installment sale work?

If the buyer pays over time, you can generally report the gain as payments arrive instead of all in the year of sale. Part of each payment is a return of your basis, part is gain and part is interest. It is reported on Form 6252.

Per IRS Publication 537, some income cannot be deferred: depreciation recapture is taxed in the year of sale even if you receive no cash that year, and inventory sales do not qualify. Plan for the cash to pay that tax.

The trade-off is risk. An installment note makes you the buyer's lender. If the business struggles, payments can stop. Security, guarantees and the interest rate matter as much as the tax.

How do state taxes affect a business sale?

Your state of residence generally taxes gain from selling stock or an ownership interest. Gain from selling assets can also be taxed by the states where the business operates. Rates and rules differ widely.

Owners sometimes plan to move before a sale. States look closely at residency changes made around a big transaction, so a move has to be real, documented and well timed. If the business operates in several states, the allocation of gain between them needs its own review.

If your business is a C corporation, ask early whether its stock could qualify for the qualified small business stock exclusion. The rules are strict, but when they apply, part or all of the gain can be excluded from federal tax.

When should tax planning for a sale start?

Ideally a year or more before a sale, and no later than before you sign a letter of intent. That leaves time to clean up the financials, review the entity, and model the deal structures.

1. Get clean, consistent financials. Buyers pay for numbers they trust. Current, reconciled statements support the price.
2. Model the structures. Compare stock and asset sales, installment terms and earnouts after tax, not just on price.
3. Review owner pay and add-backs. Above-market or below-market owner pay changes how buyers see profit.
4. Check your state picture. Residency, where the business operates and how gain is sourced.
5. Coordinate with your attorney. The allocation, non-compete and payment terms belong in the agreement.

Next step

An exit is the biggest tax event most owners ever have. We build the projections in our tax planning engagements, and outsourced accounting and CFO support keeps the numbers ready for a buyer. We work with business owners nationwide. Book a free discovery call to talk about timing.