If you’re a business owner thinking about selling your company, you’re probably laser-focused on the sales price. And that makes sense. It’s the number that people see, talk about, and negotiate, given the numerous factors that impact transaction value. But here’s the truth: what matters most is not the price you get, but the amount you keep after taxes.
Depending on how your deal is structured, you could surrender 20%–40% of your proceeds to taxes. Two business owners could sell similar companies for $10 million, and one might walk away with $8 million while the other walks with $6 million. The difference comes down to how much of the sale is taxed as ordinary income versus capital gains.
This post breaks down the key tax concepts every owner should understand before heading into a sale process, and how you can put yourself in the best position to keep more of what you’ve built.
Two Kinds of Tax, Two Very Different Outcomes
The IRS taxes business sale proceeds in two main ways: capital gains and ordinary income.
Capital gains apply when you sell stock in the business that has been held for more than a year. If you qualify for long-term capital gains treatment, your federal tax rate is usually 15% or 20%, depending on your income level. This is the best-case scenario for sellers.
Ordinary income, on the other hand, is taxed at your regular income tax rate, up to 37% federally. Add state taxes on top, and you could be looking at an effective rate of 40% or more. Ordinary income tax applies to things like compensation, consulting fees, and some parts of your deal structure that don’t qualify as a capital asset sale.
As a seller, the goal should be to maximize the amount of proceeds taxed as capital gains.
Why Deal Structure Matters
Most business sales are structured one of two ways: a stock sale or an asset sale. This is a significant negotiation point for both the buyer and seller, as it has a huge impact on both parties’ future tax liability.
In a stock sale, you sell your ownership interest in the business. This is usually the simplest and most tax-efficient path for you as the seller, because most or all of your proceeds are treated as capital gains.
On the other hand, buyers typically prefer an asset sale where they buy the equipment, customer contracts, intellectual property, and other individual assets. This lets them write up the assets’ tax basis to fair value, known as a “step up”, and depreciate the assets, which lowers their future tax liability.
The problem for you as the seller? In an asset sale, the IRS considers part of what you receive to be ordinary income. For example, if you previously depreciated some of your equipment, the IRS may recapture that depreciation and tax it at as ordinary income. Payments for non-compete agreements or post-sale consulting are also taxed as ordinary income. An asset sale will have even greater consequences if your company is a C Corporation, as you will be taxed twice, first at the corporate level when the company sells its assets, and then again when the company distributes the proceeds to you.
Even if your deal is structured as a stock sale, other pieces of the transaction can still trigger ordinary income. For example:
- If the buyer allocates part of the purchase price to a non-compete agreement, that amount is taxed as ordinary income.
- If you’re asked to stay on for a year or two as a consultant or executive post-sale, your compensation is taxed at ordinary income rates.
- If part of your proceeds come in the form of an earnout, a future payment based on how the company performs, those payments could also be taxed as ordinary income, especially if they’re tied to your continued involvement.
This is where a lot of business owners get tripped up. On paper, the headline price looks great. But when the final wire hits, taxes eat into far more than expected.
So What Can You Do About It?
The most important thing you can do is start thinking about taxes early, ideally at least a year or two before you plan to sell. Some tax strategies can only be implemented in advance, so the earlier you begin planning, the better.
You should work with an investment banker, CPA, or tax advisor to model different deal outcomes. Ask your advisors how different structures (asset vs. stock), payment methods (cash vs. earnout), or entity types (S Corp vs. C Corp) will affect your final after-tax proceeds and work to maximize after-tax proceeds.
Depending on your situation, you might benefit from:
- Restructuring your entity to improve asset sale outcomes
- Spinning off real estate into a separate entity, and leasing it back to the business
- Deferring taxes through rolled equity, a seller’s note, or a future earnout not linked to your continued involvement
- Avoiding service-based earnouts or compensation linkages that trigger higher rates
- Working with a financial advisor / wealth manager to implement an investing strategy to offset some gains
Final Thoughts: Know What You’re Really Taking Home
Selling your business is probably one of the biggest financial decisions of your life. Don’t let taxes take you by surprise. The difference between ordinary income and capital gains can dramatically impact your retirement, next business venture, or the legacy you leave behind.
Work with qualified advisors. Ask tough questions about tax structure. And don’t assume that price is the same as payout. Because at the end of the day, what matters isn’t what the buyer pays, it’s what you keep.
