Short answer
Most of a business sale is taxed as long-term capital gain at 20 percent federal, plus state tax. But several pieces are taxed as ordinary income at up to 37 percent: payments for a non-compete, consulting or transition work, and depreciation you already took on equipment and vehicles. Rollover equity you take in the buyer's company is usually not taxed at closing; that tax is deferred, not forgiven. If your business was a C corporation in a qualifying field, QSBS can exclude a large amount of the gain entirely. The split between capital gain and ordinary income is set by the purchase price allocation in the deal documents, so the time to influence your tax bill is before you sign the letter of intent.
Key facts
- Federal long-term capital gain rate (2026)
- 20% for nearly every business seller, plus 3.8% net investment income tax on most.
- Federal ordinary rate (2026)
- 37% above $768,700 married filing jointly; $640,600 single.
- What is ordinary income
- Non-compete payments, consulting or transition pay, and equipment or vehicle depreciation recapture.
- Rollover equity
- Deferred under Section 721 or 351 if structured correctly. The gain comes due at the second sale.
- QSBS
- Can exclude up to $15 million of gain if the business was a qualifying C corporation. See the QSBS page.
- The form that decides the split
- Form 8594 (purchase price allocation under Section 1060). Buyer and seller file matching copies.
Why the headline number is not your number
An offer of 8 times EBITDA gives you an enterprise value, and that number tends to lodge in an owner's head as the amount they are getting. It is not. Before any of it reaches you, the deal carves out the piece you roll back into the buyer, the piece parked in escrow, and the advisor fees, and then the tax takes its share of what is left. The four together explain why owners who plan around the headline are the ones who get surprised. This page handles the tax; the calculator stacks all four.
Tax on a business sale is unusual because the same dollar can be taxed at 20 percent or at 37 percent, or in some cases at zero, depending on what the contract calls it and how the business was set up. Nobody at the IRS decides that. The two sides of the deal decide most of it when they write the purchase price allocation, and the buyer often cares much less about the split than you should.
What the IRS sees when a business is sold
To the tax code there is no such thing as selling "the business" as one item. The price is spread across a list of separate assets, each taxed on its own terms, and Section 1060 makes the buyer and you report that split the same way on Form 8594. Pull an owner-run company apart and it looks like this.
| What is being sold | Your federal rate | Buyer's treatment |
|---|---|---|
| Goodwill of the business | Long-term capital gain, 20% | Deducted over 15 years |
| Your personal goodwill (sold by you, not the company) | Long-term capital gain, 20% | Deducted over 15 years |
| Covenant not to compete | Ordinary income, up to 37% | Deducted over 15 years regardless of the covenant's term |
| Consulting, transition, or retention pay | Ordinary income plus payroll tax | Deducted when paid |
| Equipment, vehicles, machinery already depreciated | Ordinary income up to the depreciation taken (Section 1245); excess is capital gain | New basis, bonus depreciation |
| Accounts receivable (cash-basis business) | Ordinary income | Basis equals price paid |
| Inventory and supplies | Ordinary income | Deducted as used |
Look at the buyer's column. Almost everything is deducted over the same 15 years whether it is called goodwill or a non-compete, which is why the buyer's advisors are often relaxed about the split. For you, moving a dollar from goodwill to the non-compete raises the federal tax on it from 20 cents to 37 cents. On a $1 million covenant allocation that is roughly $170,000 of extra federal tax, before state tax, for the same total price.
Is the rollover taxed at closing?
Usually not. Nearly every private equity deal asks you to take 20 to 40 percent of the price as equity in the buyer's holding company rather than cash. If the deal is a contribution to a partnership (Section 721) or a corporation where the contributing group ends up with control (Section 351), the rolled portion is not taxed now. Three things follow, and the third is the one to remember.
- The cash you receive is taxed now. Only the rolled portion is deferred.
- Your basis carries over. If your basis in the business was low, as it is for most owners who built rather than bought, your basis in the rollover is also low.
- Deferred means postponed, not forgiven. When the rollover is sold at the second sale, the entire value is gain, usually taxed at 23.8 percent because the 3.8 percent net investment income tax applies by then.
The rollover equity page covers the waterfall, the preferred return, and what happens if you leave. For tax, ask your deal counsel which code section the rollover relies on, whether any of it is subject to vesting, and whether the holding company is a partnership or corporation, because that decides whether you receive K-1 income you did not get in cash.
Which entity you sell from changes the answer
Most owner-run businesses are S corporations or LLCs taxed as partnerships, some are C corporations. The entity matters.
S corporation
Gain passes through to you once. The standard private equity structure for an S corporation is an F-reorganization, explained on the structure page: you form a holding company, drop your company under it, convert to an LLC, and sell LLC interests to the buyer. The buyer gets a stepped-up basis, you get capital gain on the cash and deferral on the rollover, and the business keeps its tax ID and contracts. One trap: if your S election is less than five years old, Section 1374 can tax built-in gain at 21 percent at the entity level before it reaches you. Ask your CPA when the S election was made.
C corporation
A C corporation selling its assets pays 21 percent corporate tax, and then you pay again when the cash comes out, a combined federal rate approaching 40 percent before state tax. Two tools reduce this: selling your personal goodwill directly, and QSBS, which for a qualifying C corporation can exclude the gain on your stock entirely. QSBS is the reason some owners are C corporations in the first place.
LLC or partnership
Gain on the interests is capital, with one exception the code calls "hot assets" in Section 751. Your share of cash-basis receivables and of depreciation already claimed comes out as ordinary income however the paperwork reads.
What does state tax do to the number?
State tax is the largest variable owners underestimate. California taxes capital gains as ordinary income up to 13.3 percent and does not conform to QSBS, so a California seller owes state tax on gain that is federally excluded. New York reaches up to 10.9 percent, more in New York City. Texas and Florida have no personal income tax. And the federal deduction for state taxes phases down to $10,000 in a sale year, so that state tax is mostly paid with no federal offset. Where your state offers a pass-through entity tax election, electing it for the sale year can move the state tax to the entity level where it is deductible, but the deadlines fall before most closings, so raise it early.
When none of this planning helps
- If your offer is a small all-cash price from a single buyer with no competing bid, the allocation is often non-negotiable and the bigger question is whether to sell at all.
- If the letter of intent is already signed and exclusivity has started, most structural levers are gone. What remains is timing, charitable planning that had to be finished before the sale was certain, and the after-sale plan.
- If your whole price is a few million dollars, you live in a no-tax state, and it is all goodwill, the capital gains treatment is already the outcome and a large planning engagement may not pay for itself.
The order to make decisions
Before the letter of intent
Confirm your entity type and the age of any S election. Check whether QSBS is even possible. Decide whether personal goodwill is available. Decide on any charitable gift, which must be done before the sale is practically certain. Model the deal in the calculator.
During negotiation
This is where the allocation, the code section your rollover relies on, any vesting on it, and the shape of an earnout are all still live. Settle them now, and if your state offers a pass-through entity tax election, put its deadlines on the calendar before they pass.
Before closing
Confirm the closing tax year, and if you are moving states understand that the move must be complete before the sale and that some states reach installment payments received after you leave.
After closing
File Form 8594 consistently with the buyer, set the tax aside in cash, and turn to the after-sale plan and the concentration risk of the rollover.
Questions people ask
Is the sale of my business taxed as capital gains or ordinary income?
Both. Goodwill, which is usually most of the price, is long-term capital gain at 20 percent federal. Payments allocated to a covenant not to compete, to consulting or transition work, and to equipment you already depreciated are ordinary income at up to 37 percent. The purchase price allocation in the contract sets the split, and the buyer often does not care how it is divided while you should care a great deal.
Is rollover equity taxable when I sell to private equity?
Usually not at closing. If the deal is structured as a contribution to a partnership (Section 721) or a corporation where the contributors hold control (Section 351), the rolled portion is deferred. Your basis carries over, so the full gain is taxed when the rollover equity is sold later. The cash you take at closing is taxed now.
Can QSBS make my sale tax-free?
It can exclude a large amount of federal gain, up to the greater of $15 million or ten times your basis, but only if your business was a C corporation for long enough and is not an excluded field like accounting or consulting. Most owner-run businesses are S corporations or LLCs, which do not hold QSBS. See the QSBS page for whether you qualify.
How is the non-compete payment taxed?
As ordinary income to you, at up to 37 percent federal plus state, though it is not subject to self-employment tax. The buyer deducts it over 15 years no matter how long the covenant lasts, so buyers are often indifferent to how much goes here while it costs you real money.
What is depreciation recapture?
If you wrote off equipment, vehicles, or machinery using bonus depreciation or Section 179, the gain on those assets up to the amount you deducted is taxed as ordinary income under Section 1245, recognized in the year of sale even if the rest of the price is paid over time. For an HVAC or trades business with a truck fleet and equipment, this can be a meaningful number.
Do I owe the 3.8 percent net investment income tax?
Often not on the sale of a business you actively run, because gain from a trade or business in which you materially participate is excluded under Section 1411. Expect it to apply later when you sell rollover equity, because by then you are usually a passive owner rather than an operator.
Can I deduct my state income tax on the sale?
Mostly no. The 2026 federal deduction for state taxes phases down to $10,000 at high income, and a sale year puts almost every seller there. A pass-through entity tax election, where your state offers one, can move some of that state tax to the entity level where it is deductible. Raise it with your CPA before closing.