Planning to sell your business? There is one cost that can significantly cut into your profits and that’s the capital gains tax. With interest in business sales rebounding and tax strategies under scrutiny, it’s more important than ever to plan ahead. Failing to structure your sale properly could cost you thousands in taxes. If you know what strategies to use and when to apply them, capital gains taxes can be reduced or even avoided. 

Quick Takeaways

• Selling a business often triggers capital gains tax, but the rate and amount depend on how the sale is structured (asset vs. stock sale).
• Long-term capital gains are taxed at a lower rate than short-term gains.
• Strategic asset allocation, timing, and tools like installment sales, and ESOPs can reduce your tax bill.
• Working with a tax advisor before the sale is essential.

Why Is Capital Gains Tax So Costly When Selling a Business?

When selling a business, the gain realized is often taxed at long-term capital gains rates (currently up to 20% federally, plus 3.8% net investment income tax, and potentially high state taxes depending on jurisdiction).

Depending on the deal structure, some components may also be taxed at ordinary income rates (e.g., depreciation recapture, consulting agreements, non-competes).

• Short-term capital gain: Asset owned for one year or less, taxed as ordinary income.
• Long-term capital gain: Asset held longer than one year, taxed at 0%, 15%, or 20%, depending on your income.

Key Tax Treatment Details:

• Gain on inventory and receivables are taxed as ordinary income.  If the company is on the cash basis of accounting for tax purposes, the ordinary income portion of the gain could be significant.
• Gain on the sale of fixed assets may be subject to depreciation recapture and be taxed at a higher rate than capital gains.

Why the Sale Price Allocation Matters

The way the sale price is allocated among various assets has a big impact on both the seller and buyer.

IRS Section 1060 requires allocation across these categories for an asset sale:

• Cash and bank deposits
• Marketable securities
• Accounts receivable
• Inventory
• Tangible personal property
• Intangible assets
• Goodwill

Impacts of Allocation:

• Determines the capital gains tax for the seller as well as the portion of gain that will be taxed at ordinary income tax rates
• Affects the step-up in basis for the buyer (which impacts depreciation and amortization going forward).

6 Smart Strategies to Reduce or Avoid Capital Gains Tax

1. Negotiate the Allocation Wisely- Structure the sale to favor capital assets over ordinary income items like receivables, fixed assets and inventory.
2. Consider an Installment Sale- Spread out payments and tax liabilities over multiple years, rather than taking one lump sum.
3. Time the Sale Strategically- Hold appreciated assets for more than one year to benefit from lower long-term capital gains rates.
4. Use an ESOP (Employee Stock Ownership Plan) – C-Corps Only- Sell to employees and roll the proceeds into qualified securities to defer gains.
5. Set Up a Charitable Remainder Trust (CRT)- Donate the business to a CRT before the sale avoids immediate capital gains tax, provides income for a period, and remaining value goes to a chosen charity

FAQs- Capital Gains and Business Sales

1. What is the best way to avoid or defer capital gains tax when selling a business?

Installment sales, ESOPs, and charitable trusts are among the most effective strategies. Each has its pros and cons depending on your business type and tax bracket.

2. How long do I need to hold an asset to qualify for long-term capital gains?

More than one year.

3. Is goodwill taxable in a business sale?

Yes, but it’s generally taxed at long-term capital gains rates if held longer than a year.

Let’s Talk Tax Strategy Before You Sell

Need help reducing your tax burden on an upcoming business sale?  Start a conversation with us, we’ll help you plan with confidence.