Selling your business: keep more of the price

The numbers

Picture an owner selling an S corporation’s assets for $5 million. To keep it simple, assume the whole price is gain: the equipment is fully depreciated and the goodwill has no basis. The owner works in the business, so the 3.8% net investment income tax doesn’t apply to the business gain. The buyer’s first draft puts $700,000 on a non-compete agreement. After planning, the allocation is negotiated to $100,000, a value supported by the facts, with the rest assigned to goodwill.

For illustration purposes. Tax law may change, which may change these calculations slightly.

Personal tax on the sale (federal)

Same buyer, same $5 million price, about $102,000 less federal tax. Oklahoma tax on the sale is figured separately. Oklahoma may allow a deduction for qualifying gains on Oklahoma property and Oklahoma company interests held long enough, and we confirm how it applies to your sale. Any business-level tax (for example, if the company was once a C corporation) is also figured separately.

How it works

1. Asset sale or stock sale. Buyers usually prefer to buy assets, because they can depreciate what they buy. Sellers often prefer to sell stock or ownership interests, because the gain is generally capital gain. For S corporations, some stock sales are treated as asset sales for tax purposes by election, which changes the math for both sides.
2. The price is allocated. In an asset sale, the price is split across classes of assets: cash and receivables, inventory, equipment, intangibles like customer lists, and goodwill. Each class is taxed under its own rules.
3. Each piece has its own rate. Depreciation recapture on equipment, inventory, and payments for a non-compete or consulting agreement are generally ordinary income. Goodwill held more than a year is generally capital gain.
4. Timing can be planned. With an installment sale, where the buyer pays over several years, you generally pay tax on the gain as payments come in. Earnouts and seller financing change the timing too.
5. Buyer and seller report the same allocation. Both file Form 8594, so the allocation in the purchase agreement is what the IRS sees.

Who it fits

• Owners planning to sell in the next one to five years, or who have received an offer.
• Businesses with heavily depreciated equipment, a lot of goodwill, or a buyer asking for a non-compete or consulting agreement.
• Owners deciding between a sale to a third party, a sale to family or employees, or seller financing.

When it doesn’t move the needle

• Sales where nearly all value is in equipment or inventory, since those pieces are ordinary income either way.
• Deals that are already signed. After the purchase agreement is final, the allocation is usually set.

The rules

• Allocations must reflect real value. The IRS can challenge an allocation that doesn’t match the facts. We support values with appraisals or reasonable methods, and buyer and seller must report consistently.
• Recapture comes first. Gain on equipment, up to the depreciation you’ve taken, is ordinary income. In an installment sale, recapture is generally taxed in the year of sale, even if you haven’t been paid yet.
• Large installment sales. When installment balances are over $5 million at year end, an interest charge on the deferred tax can apply.
• Net investment income tax. For owners who work in the business, gain from selling an active business is often exempt from the 3.8% tax. Passive owners may owe it.
• C corporation history. An S corporation that was once a C corporation may owe built-in gains tax on an asset sale within five years of converting.

Risks and costs to weigh

• Negotiation trade-offs. A better allocation for you can cost the buyer depreciation, so they may ask for something in return.
• Installment risk. If the buyer stops paying, you carry the risk. Seller financing needs strong terms and security.
• Timing. The best savings come from planning before the letter of intent. Some steps, like Section 1202 for a C corporation, need years of lead time.
• A team effort. Your attorney, any broker, and your tax strategist should work from the same numbers.

How we handle it for clients

With a Cannon & Brown tax plan, we model your sale before you negotiate it: asset or stock sale, the allocation the buyer proposes and a better-supported version, installment and earnout timing, and the federal and Oklahoma tax on each version, kept separate from any business-level tax. Because our technology keeps your numbers current all year, we can test each version of the deal against your real numbers quickly while terms are still moving. Your tax strategist reviews every recommendation.

Illustrative example. The owner and figures on this page are hypothetical, used to explain how the strategy works. They are not a client and not a promise of results. The example assumes an S corporation asset sale, the whole price treated as gain, the 37% top ordinary rate, the 20% capital gains rate, and no net investment income tax because the owner is active in the business. This page is educational and is not tax or legal advice for your situation; tax rules and limits change.