Hidden Tax Traps to Avoid When Selling a Business

21 May 2025

Selling a business is a huge milestone. But while you're busy negotiating deals, celebrating your hard work, and planning your next move, there's a lurking danger that can eat into your profits—taxes.

Many business owners underestimate the impact of taxes when they sell their company. Worse, some hidden tax traps can catch even the most financially savvy off guard. If you're not careful, Uncle Sam could take a bigger bite than you expected.

So, how do you keep more money in your pocket and avoid unnecessary tax pitfalls? Let’s break it down, step by step.

1. Neglecting Tax Planning Before the Sale

One of the biggest mistakes sellers make is waiting until the sale is finalized before thinking about taxes. By then, it’s too late! Proper tax planning should start months (or even years) before you sell.

Why? Because how you structure the deal can drastically impact how much in taxes you owe.

For example, should you sell your business as an asset sale or a stock sale? Each has different tax implications. If you don’t plan ahead, you might end up paying way more than necessary.

Pro tip: Work with a tax professional early on. The right strategy could save you thousands—if not millions—in taxes.

2. Not Understanding Capital Gains Tax

When you sell a business, the IRS typically treats it as a capital gain. This means you owe taxes on the profit you make from the sale.

But here’s the thing—capital gains come in two flavors:

- Short-term capital gains (if you owned the business for less than a year) are taxed as ordinary income, which could be as high as 37%.
- Long-term capital gains (for businesses owned over a year) get a lower tax rate—typically 15-20%.

Selling at the wrong time can cost you big. If you can, hold off until you qualify for long-term capital gains treatment to reduce your tax burden.

3. Overlooking State and Local Taxes

Federal taxes aren’t the only ones you need to worry about. Different states have vastly different tax rates, and some have no state income tax at all.

For example, if you sell your business in California, you could face state capital gains taxes of up to 13.3%. But if you structure your deal correctly or relocate beforehand, you might save a fortune in state taxes.

Before you sell, check:

- Does your state tax capital gains?
- Would you benefit from relocating or restructuring?
- Are local city taxes applicable?

A little research can go a long way in minimizing these extra tax bites.

4. Mishandling an Asset vs. Stock Sale

One of the biggest tax traps lies in how your business sale is structured. You generally have two options:

- Stock sale – You sell the company's shares, and the buyer takes over everything. These sales often get better tax treatment for the seller.
- Asset sale – You sell individual business assets (like equipment, inventory, goodwill, etc.). However, the IRS treats different assets differently, which can lead to higher taxes.

Most buyers prefer asset sales because they can "step up" the value of assets for depreciation purposes. But for you, the seller, this usually means higher ordinary income tax instead of capital gains tax.

Pro tip: Negotiate a deal that balances tax advantages for both you and the buyer. A skilled tax advisor can help structure the sale in a way that minimizes your tax liability.

5. Forgetting About Depreciation Recapture

Here’s a nasty little surprise for sellers—depreciation recapture.

If you've deducted depreciation on business assets over the years, the IRS wants some of that back when you sell. Instead of getting taxed at the lower capital gains rate, depreciation recapture is taxed as ordinary income—ouch!

For example, if you bought a piece of equipment for $50,000 and depreciated $30,000 of it, when you sell it, you’ll owe taxes on that $30,000 at a higher rate.

Ignoring this tax trap can lead to an unexpected bill. Make sure you understand how much depreciation recapture will cost you before finalizing the sale.

6. Not Considering Installment Sales

A large lump sum from selling your business can push you into a higher tax bracket, meaning more of your money goes to the IRS. Instead, consider an installment sale.

An installment sale allows you to spread the payments (and the taxable income) over multiple years. This strategy:

- Lowers your overall tax rate
- Spreads out your capital gains tax liability
- Can provide steady cash flow instead of a one-time payout

Of course, installment sales come with risks—like the buyer defaulting on payments. But if structured properly, they can be a smart way to limit your tax burden.

7. Ignoring the Net Investment Income Tax (NIIT)

Many business owners overlook a sneaky additional tax—the Net Investment Income Tax (NIIT). If your income is high enough, this 3.8% tax applies to capital gains.

Who does it affect? If your adjusted gross income (AGI) is over:

- $200,000 for individuals
- $250,000 for married couples filing jointly

Then, congrats—you owe an extra 3.8% tax on your capital gains.

If a business sale will push you over that threshold, consider strategies like installment sales or spreading the sale across tax years to reduce your exposure.

8. Underestimating Employment Taxes for Seller Financing

If you finance part of the sale (meaning the buyer pays you over time instead of all at once), watch out for self-employment taxes.

Certain parts of your business sale—like consulting agreements or earn-outs—might be classified as ordinary income instead of capital gains. That means you could owe an extra 15.3% in self-employment taxes.

What to do? Work with a CPA to ensure portions of your seller financing aren't taxed as self-employment income. Proper structuring can save you thousands.

9. Failing to Maximize Tax Deductions Before the Sale

You may be able to lower your tax bill by maximizing deductions before selling your business.

Consider:

- Prepaying business expenses
- Making retirement contributions
- Taking advantage of tax credits

The goal? Reduce your taxable income in the year of the sale so the overall tax hit is lower.

10. Not Factoring in Estate and Gift Taxes

If your business is highly valuable, selling it could create estate tax problems down the line. The federal estate tax exemption is high, but it isn’t permanent.

Plus, if you plan to pass some of the proceeds to your kids or heirs, you need to consider gift taxes. Strategic planning—like gifting shares before a sale—can help reduce tax burdens.

Final Thoughts

Selling a business isn’t just about getting the best price—it’s also about keeping the most money after taxes. The last thing you want is to hand over a significant chunk of your hard-earned profits to the IRS because of poor planning.

By understanding these hidden tax traps and working with a skilled tax advisor, you can walk away from the deal with more money in your pocket and fewer regrets.

When in doubt? Get the right experts in your corner. The cost of smart tax planning is nothing compared to the tax bill you could face if you don’t prepare.