The sale of a business is typically treated as a capital gain for federal tax purposes. The long-term capital gains rate for high-income taxpayers is currently 20%, plus a 3.8% Net Investment Income Tax (NIIT), for a combined federal rate of 23.8%.
State taxes vary significantly. Texas has no state income tax – a meaningful advantage for Texas-based sellers. Other states may add 5 – 13% in additional state tax, making deal structure and residency planning critically important.
The character of the gain – ordinary income vs. capital gain – depends on deal structure and how the purchase price is allocated across asset categories. Depreciation recapture, for example, is taxed at ordinary income rates.
The choice between an asset sale and a stock sale has major tax implications and is often one of the most negotiated structural elements.
Asset Sale: The buyer purchases individual assets. The buyer benefits from a stepped-up tax basis (higher depreciation deductions). The seller may face higher taxes because some gain is treated as ordinary income through depreciation recapture. Most buyers prefer asset sales.
Stock Sale: The buyer purchases ownership interests (stock or LLC membership interests). The seller typically prefers this structure because the entire gain is treated as long-term capital gain. The buyer doesn’t get a stepped-up basis unless a Section 338(h)(10) election is made.
In practice, buyers often compensate sellers for accepting an asset sale structure through a higher purchase price – a negotiation your M&A advisor should manage carefully.
An installment sale allows the seller to defer recognition of gain over the payment period, spreading tax liability across multiple years. This can be advantageous for keeping the seller in a lower tax bracket or managing AMT exposure.
Seller notes – promissory notes from the buyer – are common in lower middle market transactions. They typically carry interest rates of 5 – 8% and may be secured by business assets or a parent company guarantee.
The tradeoff is credit risk: you’re essentially financing part of the purchase price. Evaluate the buyer’s financial strength, the security package, and the subordination structure carefully before agreeing to significant seller financing.
Section 1202 of the Internal Revenue Code allows eligible shareholders to exclude up to $10 million (or 10× their basis) of gain from the sale of Qualified Small Business Stock (QSBS).
To qualify, the stock must have been: issued by a C corporation with gross assets under $50M at the time of issuance, held for more than 5 years, and acquired at original issuance (not purchased on a secondary market).
If your business qualifies, Section 1202 can eliminate federal capital gains tax entirely – one of the most powerful tax planning tools available to founders. However, the requirements are specific and complex. Early planning with a qualified tax advisor is essential.
Tax planning for a business sale should begin well before the transaction – ideally 12 – 24 months prior. Key planning areas include:
Entity structure optimization (C corp vs. S corp vs. LLC), Section 1202 eligibility assessment, state residency and nexus planning, estate planning strategies (grantor trusts, GRATs, family limited partnerships), charitable giving strategies (donor-advised funds, charitable remainder trusts), and Opportunity Zone reinvestment for capital gains deferral.
Parkland Capital Partners works closely with your tax advisors to ensure deal structure maximizes after-tax proceeds. We model multiple scenarios so you understand the true net outcome of each offer.
Parkland models multiple deal structures to show net proceeds under different tax scenarios.
