Short answer
In 2026, more of a business sale is paid over time, through earnouts, seller notes, and rollover equity, as buyers and sellers bridge a gap on price. When you are paid later, the installment method usually spreads your gain over the years you receive the money, and contingent earnouts have their own timing rules. Three things catch owners off guard. Deferred payments carry imputed interest, which is taxed as ordinary income, so part of what looks like sale price is really interest. An earnout tied to your staying and working can be recharacterized as wages, taxed at ordinary rates with payroll tax. And if your deferred balances are large, Section 453A adds an interest charge for the privilege of deferring the tax. Some gain, like depreciation recapture, is taxed in full in year one no matter how slowly you are paid, and you can elect out of installment reporting entirely if paying the tax up front is better for you.
Key facts
- The installment method
- Spreads your gain across the years you receive payment, so you pay tax as the money arrives rather than all at closing.
- Contingent earnouts
- Timed under special rules: a stated maximum price recovers basis against that maximum; a fixed period spreads basis ratably; neither means basis is spread over 15 years.
- Imputed interest
- Deferred payments carry interest under Sections 483 and 1274, taxed to you as ordinary income even if the contract calls it price.
- The employment trap
- An earnout that requires you to keep working can be recharacterized as compensation, taxed as ordinary wages with payroll tax.
- Section 453A
- An interest charge applies when installment notes from sales over $150,000 leave more than $5 million of face amount outstanding at year-end.
- Recapture in year one
- Depreciation recapture under Section 453(i) is taxed in the year of sale even if you are paid over time.
Why so much of a 2026 sale comes later
A generation ago the picture of selling a business was simple: you signed, you got a check, you were done. Today, and especially in 2026, a large share of the price often arrives in later years. Buyers and sellers frequently disagree on what a business is worth, and deferring part of the price is how they close the gap. An earnout pays you more only if the business hits agreed targets. A seller note pays you over a few years with interest. Rollover equity gives you a stake in the next sale. When borrowing is expensive, buyers lean harder on all three to reduce the cash they need at closing.
For you this means the tax on a sale is no longer a single event. It stretches across years, follows rules most owners have never heard of, and hides a few traps that can turn capital gain into ordinary income or add an interest charge you did not budget for. This page walks through how deferred payments are taxed and what to watch. The character of each dollar, capital gain or ordinary, is set by the allocation covered on the how a sale is taxed page; here the question is timing and the surprises that ride with it.
The installment method: paying tax as the money arrives
When you are paid over more than one year, the default is the installment method. Instead of paying tax on all of your gain at closing, you pay it as the cash comes in. Each payment is split into a return of your basis, which is not taxed, and gain, which is. This can keep you out of the very top of the brackets in any one year and lines the tax up with the money, which helps cash flow and can lower the total rate.
Two limits matter. The installment method changes when you pay, not what character the income has, so capital gain stays capital gain and ordinary pieces stay ordinary. And it does not cover everything. Some items, described below, are taxed in full in the year of sale no matter how slowly you are actually paid.
How an earnout is taxed when the number is not fixed
An earnout is harder than a fixed note because the total is unknown at closing. The regulations, in Temporary Regulation 15A.453-1(c), handle this with three rules that depend on how the earnout is written.
- If the contract sets a stated maximum you could receive, you recover your basis against that maximum, as if you will earn the full amount, and adjust later if you do not.
- If there is no maximum but the earnout runs for a fixed number of years, you spread your basis evenly across those years.
- If there is neither a cap nor a fixed period, you recover your basis over 15 years.
The point to take away is that the wording of the earnout changes your tax timing directly. A stated maximum front-loads your gain because basis is spread thin against a large number; a fixed period spreads it more evenly. In rare cases where the future payments are so speculative that they cannot be valued at all, older law under Burnet v. Logan allows open-transaction treatment, where you recover all your basis before reporting any gain, but the IRS treats that as exceptional and you should not plan on it.
Imputed interest: part of your price is really interest
Whenever payments are stretched over time, the tax code assumes some of what you receive is interest for waiting, even if the contract calls every dollar purchase price. Under Sections 483 and 1274, a portion of each deferred payment is treated as interest and taxed to you as ordinary income, not capital gain. If the note does not state a reasonable rate, the IRS imputes one for you.
The consequence is that some of what feels like your sale price is quietly taxed at a higher rate. Two responses help. Have the note state an adequate interest rate so the split is predictable rather than imputed. And ask your CPA to show you how much of each payment is interest, so you are not surprised when a chunk of your capital-gain deal turns out to be ordinary interest income.
The earnout that becomes a paycheck
If your earnout is contingent on you continuing to work for the buyer, the IRS can treat it as compensation for those services rather than as part of the sale price. Compensation is ordinary income at up to 37 percent and carries payroll or self-employment tax on top, while sale proceeds are capital gain at 20 percent with no payroll tax. On a large earnout that difference can be a seven-figure swing.
To keep an earnout on the sale side, it should depend on the business's results and be payable to you as a former owner whether or not you stay, not framed as a reward for sticking around. If the buyer genuinely wants to pay you for continuing to work, that is fine, but it should be a separate, clearly labeled employment or consulting arrangement, priced on its own, so it does not contaminate the earnout. Your deal counsel has to draft these two things apart from each other.
Section 453A: the interest charge on large deferred balances
Deferring tax through a big seller note is a benefit, and above a threshold the government charges you for it. Section 453A applies when your installment obligations from sales over $150,000 leave more than $5 million of face amount outstanding at the end of a year. On the deferred tax attributable to the balance above that $5 million line, the code adds an interest charge, recalculated each year the large balance remains outstanding. For an individual seller, that charge is not deductible.
The charge does not wipe out the value of spreading the tax, but it does shrink it, and on a large note it can shrink it enough to change your decision. If your deferred balance will run well past $5 million, have your CPA model the note both with the installment method and the 453A charge, and against the alternative of electing out and paying the tax up front. Sometimes deferral still wins; sometimes it does not.
The gain that is taxed now no matter what
Not all of your gain gets to wait for the cash. If you took bonus depreciation or Section 179 deductions on equipment, trucks, or machinery, the depreciation recapture on those assets is ordinary income, and under Section 453(i) it is taxed in the year of sale even if you are paid over ten years. For a trades business with a vehicle fleet and equipment, this can be a meaningful bill due at closing while much of your cash is still years away. Plan for it, because the recapture does not stretch out with the rest of the price.
Electing out: choosing to pay it all now
You are not required to use the installment method. Under Section 453(d) you can elect out and report your entire gain in the year of sale. Paying tax sooner sounds like the wrong choice, but it can be the right one. It makes sense if you expect tax rates to be higher in future years, if you want to use a low-income sale year or a large deduction now, if the buyer's ability to pay is uncertain and you would rather not carry the risk on top of deferred tax, or if reporting it all now avoids the 453A interest charge on a large balance. The election is hard to reverse once made, so model it with your CPA before the return is filed rather than after.
State tax follows the money, even after you move
Deferred payments raise a state question that catches movers off guard. If you plan to sell and then relocate to a no-tax state like Florida or Texas before the later payments arrive, do not assume the state you left cannot tax them. States differ, and some reach installment payments received after you become a nonresident. California, for example, sources income from the sale of a business interest under its own rules, and a former resident can still owe California tax on gain the state treats as California-source. Check the sourcing rules of the state you are leaving before you count on the move to erase the tax on your future payments.
When this does not apply to you
If your deal is all cash at closing, most of this page is background rather than action. There is no installment timing to manage, no 453A charge, and no earnout to police, though imputed interest can still touch any small holdback paid the next year and depreciation recapture is still due in the sale year. Likewise, if your deferred pieces are modest, well under the $5 million line, the 453A charge will not reach you and the main things to watch are simply keeping any earnout off the employment side and knowing how much of each payment is interest. The rules on this page earn their keep on larger, more structured deals with real earnouts, big notes, or a plan to move states.
What to do next
Before you agree to how the price is paid, get three answers. How is each deferred piece written, an earnout with a cap or without, a note with a stated rate or not, and what does that do to your tax timing? Is any earnout tied to your continued work in a way that could turn it into wages? And will your deferred balance cross the $5 million line where Section 453A bites? Take those to your CPA and deal counsel while the terms are still open, and model the deal, including the pieces paid over time and your rollover, in the after-tax proceeds calculator. Because earnouts and notes create tax bills in years when the business no longer pays you, they also shape the plan for the money afterward, which is the subject of the after-sale plan. If you want help fitting the deferred pieces into that plan, that is what a first conversation is for.
Questions people ask
Why are more 2026 deals paid over time?
Because buyers and sellers often disagree on what a business is worth, and deferring part of the price is how they meet in the middle. An earnout lets the buyer pay more only if the business performs, a seller note lets them pay over a few years, and rollover equity lets you share in the next sale. When financing is expensive, buyers lean on these tools to lower the cash they need at closing. For you that means more of your price shows up in later years, and the tax rules for deferred payments matter more than they used to.
How does the installment method tax me?
It spreads your gain across the years you actually receive payment. Each payment is treated as part return of your basis and part gain, so you pay tax on the gain piece as the cash arrives rather than all at once at closing. This can keep you in lower brackets and match the tax to the money. It does not change the character of the gain, so capital gain stays capital gain and ordinary pieces stay ordinary. And it does not apply to everything: depreciation recapture and certain other items are taxed up front regardless.
How is an earnout taxed when the amount is not fixed?
Under contingent-payment rules in the regulations. If the contract sets a stated maximum you could receive, your basis is recovered against that maximum as if you will hit it. If there is no maximum but a fixed number of years, your basis is spread evenly over those years. If there is neither a cap nor a fixed period, your basis is recovered over 15 years. These rules decide how much of each earnout payment is taxable gain and when, so the way the earnout is written in the contract directly changes your tax timing.
What is imputed interest and why do I owe it?
When someone pays you over time, the tax code assumes part of what you receive is interest for waiting, even if the contract calls all of it purchase price. Under Sections 483 and 1274, a portion of each deferred payment is treated as interest and taxed to you as ordinary income rather than capital gain. If the deal does not state a reasonable interest rate, the IRS imputes one. The practical effect is that some of what feels like your sale price is really interest, taxed at a higher rate, so it pays to have the note state an adequate rate and to know how much of each payment is interest.
Can an earnout be treated as wages instead of sale price?
Yes, and this is a costly trap. If your earnout is contingent on you continuing to work for the buyer, the IRS can treat it as compensation for those services rather than as part of the sale price. Compensation is ordinary income at up to 37 percent and carries payroll or self-employment tax on top, while sale proceeds are usually capital gain at 20 percent with no payroll tax. To keep an earnout on the sale side, it should be tied to the business's results and payable to you as a former owner whether or not you stay, not structured as a reward for staying.
What is the Section 453A interest charge?
It is an extra charge for deferring a large amount of tax through installment notes. When your installment obligations from sales over $150,000 leave more than $5 million of face amount outstanding at the end of a year, Section 453A applies an interest charge on the deferred tax for the balance above that $5 million line. The charge is calculated each year the large balance stays outstanding, and for an individual it is not deductible. It does not erase the benefit of spreading the tax, but it does shrink it, so on a large seller note your CPA should model whether deferral still pays after the charge.
Can I choose to pay all the tax now instead?
Yes. You can elect out of installment reporting under Section 453(d) and report the entire gain in the year of sale. That sounds backward, but it can be the right call: if you expect higher tax rates in future years, if you want to use the sale year's low income or a large deduction, if the buyer's credit is shaky, or if electing out avoids the 453A interest charge on a big balance. Once made, the election is hard to undo, so it is a decision to model carefully with your CPA before the return is filed.
Do I owe state tax on payments received after I move?
Sometimes, and this surprises people who move to a no-tax state after selling. States differ on whether they can tax installment payments received after you leave. California, for instance, sources income from the sale of a business interest under its own rules, and a former resident can still owe California tax on gain the state considers California-source. Do not assume that moving to Florida or Texas before the later payments arrive erases the state tax on them. Check the sourcing rules of the state you are leaving before you count on the saving.