Taxes on Selling a Business in California: What to Decide Before You Sign the Letter of Intent

For many business owners, selling their company is the largest financial transaction of their life. Research from the Exit Planning Institute estimates that owners have 80 to 90 percent of their financial wealth locked in their businesses¹, which matches what I see in my own work. Many put nearly every dollar they could back into the company for decades, so while peers built investment portfolios, their wealth grew inside one asset, with the goal of reaching a value that could fund their exit and support their family for generations.

What you owe when you sell a business in California depends mostly on how the deal is built, not necessarily the total amount that's agreed upon. As of October 11, 2026, federal long-term capital gains are taxed at 0, 15, or 20 percent, part of the price may be taxed as ordinary income, a 3.8 percent surtax may apply, and California taxes the gain as ordinary income at rates that can reach 13.3 percent.

That is why the details of a sale deserve so much care. A portfolio of stocks and bonds can be adjusted as markets and life change, and an allocation that stops fitting can be rebalanced over time. However, a business sale on the other hand gives you only one real chance, because once the deal closes, the price, the structure, and the allocation are largely set. Under the excitement of a buyer at the table, many owners carry a quieter worry, that a number they cannot see yet will take a large share of what they built, and that they will only learn how large after the deal is signed.

Here's how we see it after guiding owners through this transition, the tax bill follows from decisions, and many of those decisions are made before the Letter of Intent (LOI), the short document that sets the main terms of a deal. Structure, allocation, timing, and the state you file in can all shape the result, so the work is to model each choice while you still have room to make it. We approach every large, hard-to-reverse decision the same way, we run the numbers first and decide second. This guide is general education, organized in the order these questions usually come up, and your tax preparer should confirm how any of it applies to you.

1. How does the structure of the deal change what you owe?

A business can generally be sold in two ways. You can sell the ownership interest, such as stock or a partnership or limited liability company (LLC) interest, or you can sell the assets of the business. The buyer usually has a view on which one it wants, and the choice changes the tax character of what you receive.

In a sale of an ownership interest, the gain is generally measured on the interest itself and is often, though not always, treated as capital gain. In an asset sale, the purchase price is divided among the assets of the business, such as equipment, inventory, real estate, and goodwill, and each piece can be taxed differently. When the assets sold make up a trade or business and goodwill or going concern value could attach to them, the buyer and the seller generally each file Internal Revenue Service (IRS) Form 8594, Asset Acquisition Statement², which reports how the price was allocated.

That allocation matters because part of the gain on depreciable assets may be ordinary income under the depreciation recapture rules, while the remainder may be capital gain or section 1231 gain³. Buyers often want more of the price assigned to assets they can depreciate quickly, and sellers often want more assigned to goodwill, so the allocation is a negotiation, and it helps to know what each version costs you before talks begin.

Entity type changes which of these rules apply. A sole proprietorship, partnership, S corporation, and C corporation each follow their own rules on a sale, and an asset sale inside a C corporation can be taxed at the company level and again when proceeds are distributed to you, so confirming your entity is one of the first steps.

2. Which federal taxes apply to a business sale?

Gain on an asset held more than one year is generally long-term capital gain, taxed at 0, 15, or 20 percent depending on taxable income. For tax year 2026, the 20 percent rate applies to taxable income above $613,700 for married couples filing jointly and above $545,500 for single filers. The 15 percent rate applies between $98,900 and $613,700 for joint filers and between $49,450 and $545,500 for single filers.⁴

A business sale often pushes income across those lines in a single year, so a seven-figure gain may land mostly in the 20 percent band, even for an owner whose usual income sits far lower.

Some of the proceeds may be taxed at higher rates. Depreciation recapture is generally ordinary income, and the 2026 top ordinary rate is 37 percent on taxable income above $768,700 for joint filers and $640,600 for single filers.⁵ Gain on real property that counts as unrecaptured section 1250 gain is taxed at a maximum 25 percent rate.⁶

Then there is the 3.8 percent Net Investment Income Tax (NIIT), which applies to certain investment income for people whose modified adjusted gross income is above $250,000 for married couples filing jointly or $200,000 for single filers, thresholds that are not indexed for inflation.⁷ For owners, the question is how involved you were. The IRS excludes operating income from a nonpassive business from net investment income, and it counts gain from selling partnership and S corporation interests to the extent the owner was passive. An owner who ran the business every day and an investor who held a stake from the sidelines can see different results from the same sale. Because the line between active and passive is fact specific, we settle it before the sale.

Special categories, such as qualified small business stock (QSBS), carry their own federal rules, and section 3 covers how California treats them.

The practical point is that one sale price can be taxed several ways, and knowing the mix before you agree to terms gives you room to negotiate it.

3. What does California add on top of the federal tax?

California has no lower rate for capital gains. The Franchise Tax Board (FTB) states that all capital gains are taxed as ordinary income,⁸ so the state belongs in the math from the first model.

The most recent full rate schedule we verified is for tax year 2025. Its top regular rate is 12.3 percent on taxable income over $742,953 for single filers and over $1,485,906 for joint filers.⁹ The FTB's 2026 estimated tax instructions also describe an additional 1 percent Behavioral Health Services Tax, previously called the Mental Health Services Tax, on taxable income above $1,000,000.¹⁰ Together they can reach 13.3 percent at the margin, and the 2026 schedule may differ from the 2025 one.

California also parts ways with federal rules on small business stock. Its own exclusion for qualified small business stock was held invalid, and the FTB has disallowed that exclusion for tax years beginning on or after January 1, 2008.¹¹ An owner who qualifies for a federal exclusion may still owe California tax on the gain, so it is worth raising early.

Timing matters as well. The same 540-ES instructions say taxpayers with 2026 California adjusted gross income of $1,000,000 or more must base their estimated tax on their 2026 tax,¹⁰ which means a sale year can bring a large payment due within that same year.

Hypothetical example, for illustration only. Suppose a $20,000,000 gain fell entirely in the top brackets. A 20 percent federal rate plus a 13.3 percent California rate is 33.3 percent, or about $6,660,000. If the 3.8 percent NIIT also applied, the combined rate would be 37.1 percent, or about $7,420,000. Real results will vary with brackets, recapture, deductions, and credits. This is arithmetic on top marginal rates and does not estimate anyone's actual tax.

If the sale also involves real estate your company owns, or a home you plan to sell, the same California rule applies there. Our guide to capital gains tax on a California home sale covers that side, and our capital gains tax planning guide walks through how the federal and California layers stack on a large sale.

4. Installment sale or lump sum, and why decide before the Letter of Intent?

An installment sale is one where you receive at least one payment after the tax year of the sale. Under IRS rules, you generally report each year's share of the gain under the installment method, unless you elect out by the due date of the return, including extensions, for the year of the sale. You report it on Form 6252, Installment Sale Income,¹² and interest on the note is ordinary income.¹³

There are limits. The installment method is not available for inventory or for stock traded on an established securities market, and depreciation recapture is taxed in the year of sale even if no payment arrives that year.^13,3 A seller note or a payment held back until later may qualify, depending on the terms.

Spreading gain over several years may change which brackets apply, and it comes with trade-offs. You take on the risk that the buyer does not pay, tax rules and rates may change before later payments arrive, and you should confirm with your tax preparer how California treats each payment. A lump sum is simpler and removes buyer risk, though it concentrates the gain in a single year.

The LOI often sets the price, the form of payment, how the price is allocated, and a period of exclusivity with one buyer, and once those terms are agreed, your room to change them shrinks. Through our tax planning service, we model a lump sum and an installment schedule side by side, with the federal and California tax in each year, so the trade-off is visible before anything is written into a letter.

5. How will the emotions of a sale affect your money?

Selling a business is also an emotional event. For many owners the business was a daily routine, a team, and an identity, and those feelings show up in money decisions on both sides of the closing date. Naming them early is part of the plan.

Before the sale, emotion can shape the terms. Fatigue from a long process can push an owner to accept a deal just to be done, and attachment can make it hard to step back when a structure does not fit. The people who were there with you every day matter here too. Many owners want to look after long-time employees, and choices such as retention bonuses, employment agreements, or how long you stay on through the transition are often negotiated alongside the price, so it helps to decide what you want for your team before the LOI sets the frame. Your spouse and family belong in these conversations as well, because their lives change with yours.

After the sale, the change can be bigger than expected. Relationships shift when the team, the customers, and the vendors are no longer part of your week, and the sense of purpose that came with running the company needs a new home. In the Exit Planning Institute's 2023 national survey, 41 percent of owners said they had a formal, written plan for what they would do after selling.¹⁴

How you treat the money is part of this too. After decades of reinvesting in the company, a large cash balance can feel unfamiliar. Some owners hold cash far longer than their plan calls for, others make large moves quickly, and requests from friends and family can follow the news. We plan for this ahead of time, with a short list of decisions to make right away, a longer list that can wait, and a written process for moving proceeds into the long-term plan, so you have room to settle into the new chapter before making permanent choices.

6. What should the proceeds do after the sale?

On the day the sale closes, the money needs a job, and the first ones are practical. Set aside the cash for federal and California taxes, including estimated payments, hold enough in safe, liquid holdings for the next few years of spending, and then decide how a business that was most of your net worth becomes a diversified plan that can fund the life you want.

That last step is where our investment discipline comes in. We build the proceeds into a diversified portfolio that runs on rules, with defined rebalancing schedules, so decisions follow a written process in the years when markets test your patience.

Several later decisions are shaped by a high-income sale year. It can affect whether a Roth conversion makes sense in the years around the sale, how much Medicare premium surcharge, known as the Income-Related Monthly Adjustment Amount (IRMAA), you may face in a later year, and how your Required Minimum Distributions (RMDs) fit into retirement income years from now. Each depends on your income and the rules in effect at that time. Your estate plan likely deserves a fresh look too, because documents written for someone who owned a business may not fit someone who now holds cash and a portfolio, and we coordinate that update inside the same relationship through our estate planning work.

Underneath all of it is what the money is for, because money is a tool that funds a life of purpose, and the numbers mean more once that is clear. What do you want to do with your days, who do you want to support, and what do you want your wealth to do for the people and causes you care about? Those answers shape the plan, and the plan shapes the investments. Our financial planning page describes how we work with owners through this transition.

7. Are you likely fine, or at risk?

You are likely in good shape if you have confirmed your entity type, you are still a year or more from signing, your tax preparer has modeled both federal and California tax on the draft terms, and you have your basis records in hand. In that position, the work is refinement.

You may be at risk if an LOI is close to signing and nobody has modeled the allocation of the price, if you are treating the headline price as the number you will keep, if California tax has not been counted, if you have no plan for what the proceeds are meant to do, or if you have not thought about what your days and your team look like after closing. None of these is unusual, and each is easier to address before signing than after.

Where Up Capital fits

If your sale is simple, your entity type is clear, and your tax preparer has already modeled the result, you may not need more than that. If the structure is open, the gain is large, or the proceeds will fund your retirement and the next chapter of your life, a planning conversation is worth having before the LOI.

Up Capital Management is a fee-only fiduciary wealth management firm in Roseville, family-owned since 2012 and built on one idea, one firm for every part of your financial life. We are paid only by the families we serve, with no commissions or product sales, which keeps the advice focused on your plan when a large check arrives. For owners planning an exit in Placer County and the Sacramento foothills, that means the tax questions, the investments, the retirement income plan, and the estate plan are coordinated inside one relationship. We work best with households holding $1 million or more in investable assets.

Our first job is answering the question under all of this, whether you are going to be okay, and then helping you build the life the business was meant to fund. We welcome the chance to hear from you. Start a conversation with us.

Sources

1. 1.Exit Planning Institute, 2022 Colorado State of Owner Readiness Report.
2. 2.Internal Revenue Service, About Form 8594, Asset Acquisition Statement Under Section 1060.
3. 3.Internal Revenue Service, Publication 544, Sales and Other Dispositions of Assets.
4. 4.Internal Revenue Service, Revenue Procedure 2025-32, section 4.03, tax year 2026 capital gains rate thresholds.
5. 5.Internal Revenue Service, Revenue Procedure 2025-32, section 4.01, tax year 2026 ordinary income rate thresholds.
6. 6.Internal Revenue Service, Topic No. 409, Capital gains and losses.
7. 7.Internal Revenue Service, Questions and Answers on the Net Investment Income Tax.
8. 8.California Franchise Tax Board, Capital gains and losses.
9. 9.California Franchise Tax Board, 2025 California Tax Rate Schedules.
10. 10.California Franchise Tax Board, 2026 Instructions for Form 540-ES.
11. 11.California Franchise Tax Board, FTB Notice 2012-03.
12. 12.Internal Revenue Service, About Form 6252, Installment Sale Income.
13. 13.Internal Revenue Service, Topic No. 705, Installment sales.
14. 14.Exit Planning Institute, Are You Prepared to Leap Into Your Life After Exiting Your Business?.

Advisory services offered through Up Capital Management, Inc., an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training. This material is for informational and educational purposes only, reflects the opinions of the author as of the publication date, and is subject to change without notice. It does not constitute individualized tax, legal, or investment advice, and no portion should be relied upon as a recommendation for any specific person. Examples in this article are hypothetical and illustrative. Tax rules, rates, and thresholds cited were verified against the sources listed as of October 11, 2026 and may change.