Selling your business: asset or stock sale tax

Who pays tax when the whole business is sold?

An asset sale taxes the person or entity that owns the assets. A stock or partnership-interest sale generally taxes the selling owner instead. The contract, entity's federal tax classification, and any tax election determine which transaction occurred; the name on the offer is not enough. The IRS treats a lump-sum business asset sale as separate sales of its assets.

Adjusted basis starts with cost, adds improvements, and subtracts depreciation allowed or allowable. Ownership basis differs from asset basis and book equity (IRS: Publication 551; IRS: Publication 541).

Compare after-tax proceeds using actual prices, liabilities, sale costs, and payout terms: a C corporation asset sale can tax both the company and an individual shareholder on payout. IRS: sale of a business; IRS: corporate distributions.

If the buyer wants assets instead of shares, how am I taxed?

Check the last filed return and any election: an LLC's federal tax classification controls who reports the gain (IRS: LLC classification).

A qualifying S corporation share sale can be treated as an asset sale under section 338(h)(10) or 336(e), potentially triggering built-in gains tax. For 338(h)(10), a corporate buyer and every shareholder, including nonsellers, sign Form 8023 by the 15th day of the ninth month after the acquisition month; old and new corporations attach Form 8883 to their returns. For 336(e), every shareholder and the S corporation sign a binding agreement by the corporation's short-year return due date, generally the 15th day of the third month after disposition, including extensions; the corporation attaches the election statement. Neither election covers individuals selling a stand-alone C corporation (Form 8023 instructions; Form 8883 instructions; IRS section 336(e) regulations).

The C corporation federal rate is 21% on taxable income, not sale price (Form 1120 instructions). An S corporation can pay 21% built-in gains tax on preconversion gain recognized within five years of its first S corporation year; C corporation assets received with carryover basis start their own five-year period (26 U.S.C. 1374). Sale income and distributions change S corporation stock basis (IRS: S corporation stock and debt basis). For entity reporting apart from the sale, see How S corporations are taxed or How partnerships are taxed.

How do we split the price among inventory, equipment, and goodwill?

A qualifying business asset sale uses residual price allocation: goodwill cannot simply absorb the price. The split sets each asset's seller gain and buyer basis (IRS: Form 8594 instructions).

Support purchase-date values, liabilities, costs, and separate payments for services or noncompete terms (Form 8594 instructions). Agree on allocation before signing: written amounts bind both sides unless the IRS finds them inappropriate (26 U.S.C. 1060).

Both sides generally attach Form 8594 to sale-year returns when a transferred asset group is a trade or business and buyer basis equals its cost. Goodwill potential or an active trade or business under section 355 can satisfy the first test. Use Parts I–II initially and Parts I and III for later price changes. A stock sale does not qualify; a partnership-interest sale has an exception, though a deemed asset purchase can require buyer filing (Form 8594 instructions).

Form 4797 reports business-property gain: recapture in Part III, section 1231 in Part I, ordinary gain in Part II. Stock gain generally goes on Form 8949 and Schedule D. An S corporation puts Form 4797 ordinary gain on Form 1120-S line 4, net section 1231 gain on Schedule K line 9 and K-1 box 9, and built-in gains tax on Schedule D (Form 1120-S), Part III (Forms 4797, 8949, 1120-S, and Schedule D).

Why might my gain be ordinary income instead of capital gain?

Business-sale gain does not have one tax character. Inventory gain is ordinary income; depreciation recapture on equipment and some other property is ordinary income even after the more-than-one-year holding period for section 1231 (IRS: sale of a business; Publication 544).

Building gain needs a separate check: only certain depreciation is recaptured as ordinary income under section 1250. Remaining depreciation-related long-term gain may be unrecaptured section 1250 gain, a separate capital-gain rate category (Publication 544).

After recapture, net section 1231 gain can receive long-term capital-gain treatment, but net section 1231 losses from the preceding five tax years that have not been recaptured can turn part back into ordinary income. A partnership-interest sale has its own ordinary-income portion for unrealized receivables and inventory, including certain depreciation-recapture potential (Publication 544; Publication 541). A corporate shareholder's stock gain is usually capital, subject to the stock's basis and holding period. Section 1202 can exclude some C corporation stock gain; eligibility depends on the shares, issuer, and holding period. See LLC or C corporation (26 U.S.C. 1202).

For an individual, long-term capital gain can reach 20%, unrecaptured section 1250 gain 25%, and ordinary gain regular income-tax rates. Above modified adjusted gross income of $200,000 ($250,000 jointly), a 3.8% net investment income tax may apply to C corporation stock gain and passive business gain; active business asset gain is generally excluded (IRS Topic 409; IRS: net investment income tax).

A partner selling an interest with unrealized receivables or inventory must notify the partnership in writing within 30 days or by January 15 of the next year, if earlier, and attach the ordinary-gain statement to the sale-year return (Publication 541).

Can I report the gain as the buyer pays me?

An installment sale can spread eligible gain, not every part of a business sale. At least one payment must arrive after the sale year. Allocate the price and payments among the assets first; interest on the buyer's note is separate income. If stated interest is too low, part of the stated price may instead be taxed as interest (Publication 537).

An installment note can leave tax due before cash arrives. Debt and escrow affect payments. Above a $150,000 selling price, pledging the note for a loan can count as payment. If qualifying notes from the year's sales outstanding at year-end exceed $5,000,000, deferred-tax interest applies. Publicly traded stock is ineligible (Publication 537).

Sale-year gain may require estimated payments. For an individual, the usual annual penalty safe harbor is the lesser of 90% of current-year tax or 100% of prior-year tax if that return covered 12 months; the latter rises to 110% above prior-year adjusted gross income of $150,000 ($75,000 if married filing separately). Annualizing uneven income can reduce earlier payments. Corporations pay estimates too (Publication 505).

Does a sale to family change the tax?

Yes. A family transaction needs a defensible price and its own loss and installment review; a signed note does not remove related-party rules. An individual's direct transfer of property to a spouse generally recognizes no gain or loss, subject to exceptions. A below-market sale intended as a gift can be part sale and part gift, changing the gain or loss calculation. Losses on sales between certain relatives are generally nondeductible. Gain can be ordinary when you sell property the buyer can depreciate or amortize, including goodwill amortizable by the buyer, to an entity you control more than half of; family ownership can count toward control (Publication 544).

The installment method is generally unavailable for such property sold to certain related persons: payments are treated as received in the sale year unless the seller establishes that tax avoidance was not a principal purpose. If a related buyer disposes of installment property within two years and before paying the seller, gain can be accelerated under the resale rule (Publication 537). Identify the buyer's relationship, ownership, financing, and intended next sale before relying on deferred tax.

What numbers do I need before accepting an offer?

Compare each actual offer in a separate column. For an asset sale, calculate gain by asset, the business or owners' tax, and any further tax when a C corporation pays out the proceeds. For a stock or partnership-interest sale, start with the owner's proceeds and adjusted ownership basis, then separate capital and ordinary gain. Compare cash after federal and state tax, debt payoff, sale costs, and any note or escrow delay, both at closing and after later payments.

Debt assumed or paid by the buyer can enter amount realized and sometimes sale-year installment payments; list each liability in the agreement (Publication 537).

Get a written estimate for each offer before accepting its price or allocation; one percentage applied to the offer is unreliable.

Which records should I prepare for the buyer or lender?

Prepare books that reconcile to filed returns and explain the assets and debts being transferred. The IRS says business records should support income, expenses, financial statements, and tax returns (Publication 583).

• Filed federal and state income-tax returns, schedules, and ownership-basis workpapers.
• Recent profit-and-loss statements, balance sheets, general ledger, bank reconciliations, and an explanation of differences from tax returns.
• Fixed-asset register with invoices, placed-in-service dates, depreciation schedules, and disposal history.
• Inventory counts and cost records; receivables and payables aging; debt statements and payoff amounts.
• Major customer, lease, and supplier agreements that support what will actually transfer.

Give buyers or lenders a dated, consistent set of records and track adjustments separately.

My books mix the division I am selling with the rest: what do I prepare?

A division sale still needs a supportable list of transferred assets, liabilities, revenue, and costs. Selling part of a business does not turn the transferred assets into one tax asset; a qualifying group can still require residual allocation and Form 8594 (IRS: sale of a business; Form 8594 instructions).

Tie division revenue to invoices, deposits, and the ledger; document direct costs and shared-overhead allocation. Match transferred assets to invoices, depreciation, and basis, flag shared contracts, then reconcile division books to company returns. The IRS says separate businesses should keep separate records and all businesses need records that clearly show income and expenses (Publication 583).

Example

Illustrative US dollars; this is a gain calculation, not a tax quote.

A sole proprietor agrees to sell a business's assets for $500,000, with no debt or selling costs. The supported allocation is $100,000 to inventory with $60,000 basis, $150,000 to equipment with $50,000 adjusted basis after depreciation, and $250,000 to self-created goodwill held over one year with no tax basis. The inventory produces $40,000 of ordinary gain. The equipment produces $100,000 of gain; assume all of it is depreciation recapture, so it is ordinary income. The goodwill produces $250,000 of gain that may receive capital-gain treatment. Total gain is $390,000, but its parts do not face one common rate.

Suppose the buyer pays $50,000 at closing and $450,000 next year, plus adequate stated interest. The agreement assigns the closing payment and $50,000 of the note to inventory, $150,000 of the note to equipment, and $250,000 to goodwill. In the sale year, the seller reports $40,000 inventory gain and $100,000 equipment recapture, even though only $50,000 cash arrives; no goodwill principal is paid. Next year, $200,000 of inventory and equipment principal creates no new gain; the $250,000 goodwill principal produces eligible gain, with interest taxed separately. File Form 6252 for the goodwill in both years, even though the first year has no goodwill payment (Publication 537; Form 6252).

Different for you?

• You are buying the business: the buyer's basis, deductions, and liability questions belong in Buying a business.
• Another owner is buying your stake while the company continues: see Buying out a partner.
• You will dissolve the company after the sale: see Closing a company.
• The business being sold is Canadian: see Selling your business in Canada.
• You are a foreign seller of a US partnership interest, US real property, or stock of a US real property holding corporation during the shorter of your holding period or the past five years: buyer withholding can reduce closing cash. See Foreign partners and withholding and include it in a cross-border tax review (IRS: partnership withholding; IRS: FIRPTA withholding).
• You have a signed offer, a disputed allocation, a C corporation asset sale, an S corporation with a prior C corporation period, or a family sale: gather the offer, entity returns, asset and basis schedules, debt records, and payout plan for corporate tax review before finalizing the deal.