Business Owners · 7 min read
Selling the Business: The Decisions That Only Exist Before the Sale
Most of the tax bill on a business sale is settled before the papers are signed, by five decisions. What is being sold: in an asset sale every asset is taxed on its own, and depreciation already deducted on equipment returns as ordinary income. How you are paid: a note spreads the gain, with exceptions that fall due in year one. What leaves first: a gift of shares counts only while the recipient is free to keep them. The entity: qualified small business stock treatment needs a C corporation and years of holding. The people and the state: who coordinates, and where you live in the year of the sale.
A business owner's desk the week before a sale, with a purchase agreement, a legal pad of handwritten allocation figures, reading glasses, and a set of keys at the edge of the frame.
A business sale arrives as one number: the price. The tax bill behind it is set by a handful of choices made months before closing, and few of them can be revisited once the papers are signed. What is being sold, when the money arrives, what leaves the owner’s hands before a buyer is committed, the entity the shares sit in, and the state the seller lives in each carry their own rule. Most owners meet those rules in the closing binder. We think they belong at the beginning, as decisions.
Decision 1: What is being sold
A buyer can take the company’s assets or its shares, and the two are taxed very differently. In an asset sale, the IRS treats the deal as the sale of every asset in the business, with the gain on each one figured separately (IRS Publication 544, Sale of a Business). The price is spread across the assets in a fixed order, and whatever remains after every identifiable asset is priced goes to goodwill (Publication 544, Classes of assets). Both sides report that allocation on Form 8594 (IRS, About Form 8594), and an allocation agreed in writing binds both of them unless the IRS finds it inappropriate (26 U.S.C. §1060(a)).
Buyers tend to want assets. What they paid becomes their starting value in each one, and purchased goodwill is deducted over 15 years (26 U.S.C. §197(a), (d)(1)). Sellers feel the other side on the equipment. Gain on depreciable equipment and vehicles is ordinary income up to the depreciation already deducted, “notwithstanding any other provision” of the tax code (26 U.S.C. §1245(a)(1), (a)(3)). In a stock sale the seller sells one thing, the shares, and gain on shares is usually capital gain (Publication 544, Corporation interests).
| Asset sale of a $3,000,000 company | Allocated price | How the seller’s gain is generally treated |
|---|---|---|
| Inventory (Class IV) | $200,000 | Ordinary income, reported in the year of sale even if the buyer pays over time |
| Equipment and vehicles (Class V), bought for $500,000 with $350,000 depreciated | $400,000 | $250,000 of gain, all ordinary income under §1245 because it is less than the depreciation taken |
| Goodwill and going-concern value (Class VII) | $2,400,000 | The residual; the buyer deducts it over 15 years |
| Total | $3,000,000 | Illustrative. Not a recommendation. |
Both the shape of the deal and the allocation inside it are settled before the purchase agreement is drafted. A seller who knows what the equipment line costs negotiates with that number in hand.
Decision 2: When and how you are paid
A sale with at least one payment arriving after the year of the sale is an installment sale (26 U.S.C. §453(b)(1)). The seller reports gain in proportion to the payments received each year, automatically, unless the seller elects out by the return’s due date (26 U.S.C. §453(a), (c), (d)). A seller-financed note spreads the tax across the years the money arrives.
Two pieces of the price do not wait. Depreciation recapture is recognized in the year of sale whether or not a payment was received (26 U.S.C. §453(i); IRS Publication 537), and inventory cannot use the installment method at all (26 U.S.C. §453(b)(2)).
Large notes carry a second cost. When the sales price exceeds $150,000 and installment obligations outstanding at year end exceed $5,000,000 in face amount, the seller pays interest on the deferred tax at the IRS underpayment rate (26 U.S.C. §453A(b), (c)). Borrowing against the note counts as a payment on it (26 U.S.C. §453A(d)). An earn-out, where part of the price depends on results after closing, is a contingent payment sale — still reported on the installment method, under its own rules (26 C.F.R. §15a.453-1(c)).
The decision is how much of the price a household wants in hand at closing, and how much it is willing to lend. That answer belongs in the letter of intent.
Decision 3: What leaves before the sale
Some owners intend to give part of the company away, to a charity or to family, and want the gift to carry its share of the gain with it. The tax law respects that only when the gift is real before the sale is certain. The IRS treats the proceeds of a later sale or redemption as the donor’s income only if the recipient is legally bound, or can be compelled, to surrender the shares (Rev. Rul. 78-197, as restated in IRS PLR 200321010). The result holds, in the IRS’s words, “provided there is no prearranged sale contract” binding the recipient to sell (PLR 200321010).
That makes the calendar the whole question. A gift made while the charity or the child is genuinely free to keep the shares stands on its own. A gift made after a signed purchase agreement invites the IRS to treat the owner as having sold first and given cash second. A letter of intent sits between those points, and where a particular letter falls is a question for counsel before anything moves. The sequence a household can set is gift, then agreement, then sale — and the gift is a real gift.
Decision 4: The entity and qualified small business stock
Section 1202 lets a shareholder exclude gain on qualified small business stock, and the definition is narrow. The stock has to be issued by a C corporation and acquired at original issue (26 U.S.C. §1202(c)(1)). The company has to stay a C corporation and meet an active-business test for substantially all of the holding period, with at least 80 percent of its assets used in an active business (26 U.S.C. §1202(c)(2)(A), (e)(1)(A)). For stock issued after July 4, 2025, its gross assets cannot exceed $75,000,000 before and immediately after the issuance (26 U.S.C. §1202(d)(1)). An S corporation or an LLC does not issue this stock; a conversion starts the clock only on shares the C corporation then issues.
The July 4, 2025 law rewrote the schedule. For stock acquired after that date the exclusion is tiered by years held (26 U.S.C. §1202(a)(5), (a)(6)). Stock acquired between September 28, 2010 and that date keeps the older rule: 100 percent after more than five years, nothing sooner (26 U.S.C. §1202(a)(1), (a)(4)).
| Stock acquired after July 4, 2025 | Share of gain excluded |
|---|---|
| Held 3 years | 50 percent |
| Held 4 years | 75 percent |
| Held 5 years or more | 100 percent |
The exclusion is capped per company at the greater of a dollar limit or ten times what the shareholder paid for the stock. The dollar limit is $10,000,000 for stock acquired on or before July 4, 2025 and $15,000,000 for stock acquired after it, with the higher figure indexed for inflation in later years (26 U.S.C. §1202(b)(1), (b)(5)). This is the decision that only exists years ahead of a sale: the entity, the issuance date, and the holding clock are fixed long before a buyer appears.
Decision 5: The people and the state
State tax follows two facts: where the seller lives and where the income comes from. A state may tax the whole income of its residents, a principle the Supreme Court has called “universally recognized,” while nonresidents are taxed only on income from sources within the state (Oklahoma Tax Commission v. Chickasaw Nation, 515 U.S. 450 (1995)). A move timed around a sale is a residency question for a state tax professional, decided on where a household actually lives.
The people are the last decision, and usually the one made by default. The CPA owns the allocation, Form 8594, and the installment reporting. The attorney owns the purchase agreement, the entity, and the gift documents. Someone has to own the sequence: which decision comes first, what the household will have in hand at closing, and what the years after the sale look like. That is our role: decisions made once, on purpose, with someone watching the whole picture.
What this does not mean
None of this recommends an asset sale over a stock sale, a note over cash, or a gift over keeping the shares. Each is a trade between the seller, the buyer, and the calendar, and the buyer’s preferences shape the deal as much as the seller’s. A note defers tax and also concentrates a family’s wealth in one borrower’s promise. A gift is a gift; the proceeds are gone. Qualified small business stock treatment depends on facts about the company’s history that no article can verify. We describe the rules and the order they arrive in, so a household meets them as decisions rather than surprises.
Frequently asked questions
Does the buyer decide whether it is an asset sale or a stock sale?
Both sides do, in the negotiation. Buyers often prefer assets because purchased goodwill is deducted over 15 years (26 U.S.C. §197(a)); sellers often prefer shares because the gain is usually capital gain. The price moves with the structure.
If I am paid over five years, is the tax spread over five years?
Mostly. The installment method reports gain in proportion to the payments received each year (26 U.S.C. §453(c)). Depreciation recapture and inventory are taxed in the year of sale regardless, and notes above $5,000,000 in face amount carry an interest charge on the deferred tax (26 U.S.C. §453A(b)).
Can I give shares to charity after signing a letter of intent?
The test is whether the charity is legally bound, or can be compelled, to sell or surrender the shares when it receives them (Rev. Rul. 78-197, via PLR 200321010). Whether a particular letter crosses that line depends on its terms, so the gift is planned with counsel first.
My company is an S corporation. Does the qualified small business stock exclusion apply?
Not to the shares as they stand. The exclusion applies to stock issued by a C corporation and acquired at original issue (26 U.S.C. §1202(c)(1)). A conversion starts the holding clock on the shares the C corporation then issues, so the question is how many years remain before a sale.
Sources and further reading
- 26 U.S.C. §1060 — Special allocation rules for certain asset acquisitions
- IRS Publication 544 (2025), Sales and Other Dispositions of Assets — Sale of a Business; Allocation of consideration; Form 8594
- 26 U.S.C. §1245 — Gain from dispositions of certain depreciable property
- 26 U.S.C. §453 — Installment method
- 26 U.S.C. §453A — Special rules for nondealers (interest on deferred tax liability)
- 26 U.S.C. §1202 — Partial exclusion for gain from certain small business stock, as amended by Pub. L. 119-21 (July 4, 2025)
- IRS Private Letter Ruling 200321010 (2003), restating Rev. Rul. 78-197, 1978-1 C.B. 83
Keep reading
Get the weekly market brief.
Once a week, we send a concise roundup of the most important market stories and what they may mean for financial markets, portfolio decisions, and planning strategy.
The views and opinions expressed here are those of The Financial Sciences Company as of the publish date and are provided for informational and educational purposes only. They are not personalized investment, tax, or legal advice. The Financial Sciences Company, LLC is a registered investment adviser. Registration does not imply a certain level of skill or training. Additional information is available in our Form ADV at adviserinfo.sec.gov.
General educational information, current as of 2026. Figures and rules change. For guidance specific to your situation, speak with a qualified professional.