TL;DR: The federal long-term capital gains rate peaks at 20% in 2025, plus a 3.8% Net Investment Income Tax for earnings above $533,400 (single) or $600,050 (married filing jointly), putting the maximum federal rate at 23.8% on most business sale proceeds, per IRS Rev. Proc. 2024-40. What you actually pay depends on what assets are in the deal, how they are classified, and whether you live in Florida or California.
The IRS does not see your business
You spent 25 years building a plumbing company worth $4 million. The day you sign a purchase agreement, you are not selling a business in the IRS's view. You are selling inventory, receivables, equipment, customer relationships, and goodwill. Each is taxed differently, at a rate the Internal Revenue Code specifies by asset class.
This distinction matters more than almost any other factor in your exit. Get it wrong and you hand the government a check larger than necessary. Get it right and you keep an extra $200,000 to $500,000 on a mid-market deal.
Long-term capital gains rates in 2025
For assets held longer than one year, federal rates break by taxable income. The 0% rate applies under $47,025 (single) or $94,050 (married filing jointly). The 15% rate runs from there to $518,900 for single filers or $583,750 for married filers. The 20% rate triggers above those thresholds.
Most owners selling a business worth more than $2M will hit the 20% bracket. Add the 3.8% Net Investment Income Tax for earnings above $533,400 (single) or $600,050 (married), and the effective maximum federal rate on capital gains reaches 23.8%. That is the floor if you structure the deal well. It climbs fast if you do not.
What gets capital gains treatment and what does not
Not every dollar in a business sale is taxed at capital gains rates. The IRS sorts business assets into classes, and the tax rate follows the class.
Capital gains treatment:
- Goodwill: the largest asset in most service businesses, taxed at long-term capital gains rates
- Business real estate appreciation above original cost, after depreciation adjustments
- Partnership interests and stock held more than one year
Ordinary income treatment (up to 37% federal):
- Inventory: always taxed as ordinary income
- Accounts receivable above your basis
- Depreciation recapture: if you depreciated equipment or vehicles, Sections 1245 and 1250 recapture that at ordinary income rates when you sell
- Non-compete agreements: every dollar allocated here is ordinary income to you and a deduction for the buyer
- Consulting or employment agreements carried in the deal structure: taxed as compensation, including payroll taxes
The math is direct. Every dollar shifted from goodwill to a non-compete moves from a 20% rate to a 37% rate, a 17-cent difference per dollar. On a $500,000 non-compete allocation in a $5M deal, that is $85,000 in avoidable federal tax. This is why purchase price allocation matters. The IRS requires both parties to agree in writing via Form 8594, and what each side wants is almost always the opposite of what the other side wants.
Asset sale vs. stock sale
For corporations, buyers and sellers face a structural conflict. Buyers want an asset sale because it gives them higher depreciable basis on the assets they acquire. Sellers want a stock sale because the entire gain typically qualifies as long-term capital gains with no depreciation recapture.
In a stock sale, the seller pays one tax layer: long-term capital gains on the profit from the stock. No depreciation recapture. No Form 8594 negotiation. In a C-Corporation asset sale, the seller faces double taxation: the corporation pays 21% at the entity level, then the owner pays up to 23.8% on the distribution. The combined effective federal rate can exceed 40% before state taxes are added.
This is why entity structure is a pre-sale decision, not a post-LOI one. Owners with C-Corporations planning to exit in the next three to five years should consult a tax attorney about an S-Corp election well before the deal process starts. For a deeper look at how each structure affects the closing table, see our breakdown of asset sales vs. stock sales.
State taxes: the number sellers forget
Federal rates are only part of the equation. State capital gains taxes range from 0% in Florida, Texas, and Nevada to 13.3% in California. A $5M business sale generating $4M in capital gains produces a six-figure difference in what you net based solely on which state the transaction closes in.
A few specifics: Missouri eliminated its individual capital gains tax effective 2025. Washington state enacted a capital gains excise tax of 7% on gains up to $1M and 9.9% above that. New York, New Jersey, and Minnesota all top 9% on capital gains at the state level. Sellers in high-tax states who can legitimately establish residency elsewhere before the transaction closes should model the math before signing anything.
Three levers that reduce the bill
Installment sale: Spreading payments over time defers capital gains recognition over the payment schedule. The catch is that depreciation recapture must be recognized in the year of sale regardless of when payments arrive. For sellers with minimal depreciated assets and a buyer who cannot pay in full at close, installment terms can smooth a large tax event across multiple years.
Qualified Small Business Stock (Section 1202): C-Corporation shareholders who held qualifying stock for more than five years may exclude up to 100% of capital gains from federal tax. Requirements include gross corporate assets under $50M at the time of stock issuance (raised to $75M for stock issued after July 4, 2025 under the One Big Beautiful Bill Act), plus an active business test and a hold-period requirement. The Act also introduced a tiered structure: 50% exclusion at three years, 75% at four, 100% at five. The exclusion caps at the greater of $10M or 10x adjusted basis ($15M for post-Act stock). When it applies, this provision can eliminate millions in federal capital gains tax.
Opportunity Zone reinvestment: Capital gains reinvested into a Qualified Opportunity Zone fund within 180 days of the sale defer recognition until December 31, 2026. Gains on the QOZ investment itself are potentially tax-free if held long enough. Sellers who want to defer a large capital gain while deploying proceeds into real assets should run this option by a tax advisor before closing.
What this means for owners in the lower middle market
At Patriot Growth Capital, we work with business owners in the $2M to $10M EBITDA range. Most are selling once. Most have never dealt with this level of tax complexity before. The number they expect to keep and the number they actually keep after taxes and deal fees are often hundreds of thousands of dollars apart. Not because the deal was bad, but because the tax structure was not addressed until after the LOI was signed.
The time to bring in a tax attorney and a CPA is before you accept a letter of intent, not after. Purchase price allocation, entity structure, installment terms, and QSBS eligibility are all negotiated at the deal level. Post-LOI, the buyer controls most of the structural terms.
One opinion: an estimated $10 trillion in boomer-owned businesses will change hands over the next decade. Owners who understand their options before they sell keep more. Those who learn on the way to closing fund the IRS instead.
Frequently Asked Questions
What is the capital gains tax rate on a business sale in 2025?
The federal long-term capital gains rate peaks at 20% in 2025, per IRS Rev. Proc. 2024-40. An additional 3.8% Net Investment Income Tax applies for earnings above $533,400 single or $600,050 married, pushing the maximum federal rate to 23.8%. State taxes add 0% to over 13% on top of that depending on where the seller is taxed.
Is goodwill taxed as capital gains when you sell a business?
Yes. Goodwill is typically classified as a capital asset and taxed at long-term capital gains rates in a business sale. This makes it the most favorably taxed component of the transaction. Sellers want as much of the purchase price allocated to goodwill as possible; buyers want the opposite, because they prefer allocation to depreciable assets they can write off.
What is the difference between an asset sale and a stock sale for taxes?
In a stock sale, the seller pays one layer of tax: long-term capital gains on the stock profit, with no depreciation recapture and no per-asset allocation. In a C-Corporation asset sale, the corporation pays 21% at the entity level and the owner then pays up to 23.8% on the distribution, creating an effective combined federal rate above 40%. Entity structure and pre-deal planning determine which structure applies.
What is the Section 1202 QSBS exclusion for business sellers?
Section 1202 allows qualifying C-Corporation shareholders to exclude up to 100% of capital gains from federal tax on a business sale. The stock must be held for five or more years, gross corporate assets must have been under $50M at issuance (raised to $75M for post-July 2025 stock under the One Big Beautiful Bill Act), and the company must meet active-business tests. When it applies, the exclusion caps at the greater of $10M or 10x adjusted basis.
