When retiring business owners begin planning their exit, one question rises to the top almost immediately: “What taxes will I owe when I sell my business?” It’s a fair concern. The tax consequences of a sale can dramatically affect your net proceeds — and the rules are complex enough that even seasoned owners feel uncertain. The good news is that with the right structure and planning, you can often reduce your tax burden significantly.
Understanding the tax landscape starts with recognizing that not all business sales are taxed the same way. The taxes you’ll pay depend on your entity type, how the deal is structured, and how the purchase price is allocated. Let’s break it down in a way that’s practical and easy to understand.
1. Asset Sale vs. Membership Interest Sale: The Structure Drives the Taxes
The first major tax factor is whether the deal is structured as an asset sale or a membership interest (equity) sale.
Asset Sale
In an asset sale, the buyer purchases specific assets — equipment, inventory, goodwill, customer lists, etc. For the seller, this often results in a mix of:
Capital gains (taxed at favorable rates)
Ordinary income (less favorable)
Depreciation recapture (taxed at higher rates)
Depreciation recapture is often the biggest surprise for owners. If you’ve depreciated equipment or improvements over the years, the IRS may “recapture” that depreciation at higher tax rates when you sell.
Membership Interest Sale
In a membership interest sale, the buyer purchases the entity itself. For the seller, this usually results in long‑term capital gains, which are taxed at lower rates. There is typically no depreciation recapture and no need to allocate the purchase price among asset classes.
This is why many sellers prefer equity sales — but buyers often prefer asset sales for their own tax benefits.
2. Purchase Price Allocation: A Critical Tax Lever
In an asset sale, the purchase price must be allocated across various asset categories. Each category is taxed differently. For example:
Goodwill → long‑term capital gains
Equipment → depreciation recapture
Inventory → ordinary income
Non‑compete agreements → ordinary income
The allocation is negotiated between buyer and seller, and it can significantly impact your tax bill. A seller‑friendly allocation emphasizes goodwill; a buyer‑friendly allocation emphasizes depreciable assets.
This is one of the most strategic parts of the deal — and one of the most overlooked.
3. Your Entity Type Matters
Your tax outcome also depends on whether your business is structured as:
LLC
S‑Corporation
C‑Corporation
Partnership
For example:
S‑Corp and LLC owners often benefit from capital gains treatment.
C‑Corp owners may face double taxation unless the deal is structured carefully.
Partnerships have unique rules around basis and distributions.
This is why early tax planning is essential.
4. State Taxes and Special Rules
In addition to federal taxes, you may owe:
State capital gains tax
State income tax
Transfer taxes (in some jurisdictions)
Connecticut, for example, taxes capital gains as ordinary income, which can materially affect your net proceeds.
5. Strategies to Reduce Taxes
With proper planning, many owners can reduce their tax burden. Common strategies include:
Structuring the deal as a membership interest sale
Negotiating a seller‑friendly purchase price allocation
Timing the sale to maximize long‑term capital gains
Using installment sales to spread tax liability
Separating real estate into a different entity
Pre‑sale estate or retirement planning
The earlier you plan, the more options you have.
The Bottom Line
Taxes are one of the most important — and most misunderstood — parts of selling a business. The structure of the deal, the allocation of the purchase price, and your entity type all play major roles in determining what you’ll owe. With the right advisors and early planning, you can minimize your tax burden and keep more of the proceeds you’ve worked so hard to earn.
START YOUR CASE EVALUATION TODAY