What taxes will I pay when I sell my business?

Short answer: Federal long-term capital gains (20%), Medicare surtax (3.8%), state income tax (varies by state, 0 to 13%), and depreciation recapture at ordinary rates (up to 37%) all apply. An owner in a high-tax state without pre-sale planning can lose 35 to 45 cents of every dollar in proceeds to taxes. The mitigation strategies must be implemented before closing, not after.

The tax stack on a typical business sale

This is why two owners can sell businesses at the same headline price and walk away with materially different amounts. The tax outcome depends on entity structure, deal structure, state of residence, and how much pre-sale planning was done.

How entity type affects the tax outcome

S-corporations and partnerships (pass-through entities)

In a stock or membership-interest sale, gains flow through to the individual owner and are taxed at capital gains rates. This is generally the most favorable treatment for a business sale. In an asset sale, certain assets (like inventory and accounts receivable) may be taxed at ordinary income rates rather than capital gains rates, depending on the asset category.

C-corporations

A C-corporation sale involves two layers of tax: the corporation pays tax on the gain from the asset sale (21 percent federal corporate rate), and then the owner pays capital gains tax on the proceeds distributed as a dividend. This double taxation is the primary reason most middle-market owners operate as S-corps or LLCs. The significant exception is QSBS (Section 1202), which can exclude up to $10M (or 10x basis) in gains from federal tax for qualifying C-corporation shares held for at least five years. See the full QSBS article for details.

The most effective pre-sale tax strategies

• QSBS exclusion: If the business was originally structured as a C-corporation and shares were issued to the founder, qualifying stock held for five-plus years can exclude $10M or more in gains from federal tax entirely. This is the single highest-leverage tax strategy for founders who planned early.
• Charitable remainder trust (CRT): Donating appreciated business interests to a CRT before the sale avoids capital gains on the donated portion and generates an income stream. Must be structured before any definitive agreement is signed.
• Donor-advised fund (DAF) contribution: Contributing a portion of pre-sale business interests to a DAF generates an immediate charitable deduction and removes those interests from taxable proceeds. Simpler than a CRT and nearly as effective for the donated portion.
• Installment sale (seller note): Structuring a portion of the sale price as a seller note spreads gain recognition over multiple years, which can reduce the effective tax rate if the owner's marginal rate changes post-sale.
• Pre-sale estate freeze: Using GRATs, IDGTs, or family limited partnerships to shift appreciation to the next generation before the sale closes. See the full article on pre-sale estate planning.

What happens to state taxes if you move before the sale

Establishing residency in a no-income-tax state before a business sale is a strategy some owners pursue. It requires genuine domicile change, typically 183 or more days of physical presence in the new state, and it must occur well before any binding agreement to sell. States with high income taxes (California, New York, New Jersey) aggressively audit residency claims around business sales. This requires real planning with a tax attorney, not a post-LOI address change.