Tax Strategies Before You Sell: What Lower Middle Market Business Owners Should Know in 2026

A Nashville business owner I worked with a few years ago sold his company for $9M. He had been building it for 22 years. He did the math, figured out what he would clear after the broker fee, and started mentally spending money.

Then his accountant called.

After federal capital gains taxes, the net investment income tax, state taxes on certain income components, and recapture on depreciated assets, he took home approximately $5.8M on a $9M sale.

Not because anything went wrong. Not because anyone made a mistake. Just because the tax structure of the deal was never addressed before the LOI was signed, and by the time it was, most of the options were off the table.

A business sale creates the single largest taxable event in most lower middle market owners’ lives. The federal long-term capital gains rate is currently 20%, plus the 3.8% Net Investment Income Tax, for a combined federal rate of approximately 23.8% on most proceeds. Add state taxes where applicable, and depreciation recapture at ordinary income rates on certain assets, and the gap between the headline price and what you actually take home can easily be 25-35% of the sale price. The strategies that reduce this gap exist and are legal, but most of them require action 12-24 months before you sell, not the week you sign the LOI.

Here are the six strategies worth understanding.

Key Takeaways

• Federal capital gains plus Net Investment Income Tax creates a combined federal rate of approximately 23.8% on business sale proceeds for most sellers.
• Tennessee has no state income tax on capital gains, making it one of the better states in the country for business exits.
• Installment sales (Section 453) spread gain recognition across multiple years, reducing peak-year tax exposure and potential bracket creep.
• Section 1202 QSBS allows C-corporation founders and early shareholders to exclude up to $15 million or more in capital gains under rules updated by the 2025 One Big Beautiful Bill Act.
• Qualified Opportunity Zone investments now offer permanent capital gains deferral and potential exclusion, following the OBBBA making QOZ benefits permanent.
• ESOPs offer C-corporation owners the ability to defer capital gains indefinitely under Section 1042 while also eliminating corporate income tax for 100% ESOP-owned S-corporations.
• These strategies require a CPA who understands M&A transactions. A generalist accountant who does tax compliance work is not the same as one who has structured business sale transactions.

Strategy 1: The Installment Sale (Section 453)

An installment sale allows you to receive the purchase price over multiple years rather than all at close, deferring gain recognition into future tax periods. Instead of recognizing a $6M capital gain in a single year and potentially pushing income into the highest tax brackets, you spread recognition across the payment schedule.

The practical benefit: you may avoid peak-year bracket effects, reduce the Net Investment Income Tax exposure in any single year, and smooth the tax impact over time. Sellers who receive seller notes (a portion of the purchase price paid by the buyer over several years) are effectively executing an installment sale on that portion of the consideration.

The limitation: depreciation recapture (ordinary income rates on previously depreciated assets) is recognized in the year of sale regardless of installment payment structure. And some buyers, particularly PE firms, prefer all-cash transactions and will not offer installment terms without a specific reason.

A sophisticated variation is the Deferred Sales Trust, a structure where the business is sold to a trust that pays you in installments. This can provide investment flexibility on the trust assets while deferring gain recognition. The IRS views certain forms of this structure skeptically, so it requires careful structuring with experienced tax counsel.

Strategy 2: Section 1202 QSBS (Qualified Small Business Stock)

Section 1202 of the Internal Revenue Code allows shareholders in qualifying C-corporations to exclude a significant portion of capital gains from the sale of Qualified Small Business Stock. This is one of the most powerful tax benefits in the US tax code and one of the most underutilized by lower middle market business owners.

Under rules updated by the One Big Beautiful Bill Act signed in July 2025, the exclusion for QSBS acquired after the Act’s enactment date (July 4, 2025) is the greater of $15 million or 10 times the investor’s basis per company per taxpayer, a significant increase from prior limits. For QSBS acquired before that date under the original five-year holding rule, the 100% exclusion for post-2010 shares continues to apply.

The requirements are specific: the business must be a C-corporation (not S-corp), the stock must be original-issue stock held for at least five years, the corporation’s aggregate gross assets must not have exceeded $50 million when the stock was issued, and the business must operate in a qualifying trade (most operating businesses qualify; certain financial, legal, hospitality, and professional service businesses do not).

If your business qualifies, the tax math is extraordinary. An eligible seller on a $12M capital gain could exclude the entire gain from federal taxation. At a 23.8% combined federal rate, that is nearly $2.9M in federal taxes that disappear.

The catch: this requires planning in advance. The five-year holding requirement means QSBS benefits cannot be claimed by someone who just started thinking about them six months before closing. If your business is a C-corporation and you have held shares for five or more years, talk to a CPA who understands Section 1202 immediately.

Strategy 3: Qualified Opportunity Zones (QOZ)

Qualified Opportunity Zones are federally designated census tracts where private investment receives favorable tax treatment. The One Big Beautiful Bill Act of 2025 made QOZ benefits permanent, which significantly increased their attractiveness for business sellers.

The mechanism: if you sell a business and reinvest the capital gain (not the full proceeds, just the gain) into a Qualified Opportunity Zone fund within 180 days, you defer recognition of that gain. If you hold the QOZ investment for 10 or more years, the appreciation on the QOZ investment itself is excluded from federal taxation entirely.

For sellers with large capital gains who are comfortable with a 10-year investment commitment and have investment thesis alignment with QOZ sectors (real estate development and operating businesses in designated areas), this strategy can produce meaningful tax reduction.

The limitations: QOZ funds vary significantly in quality, the 10-year holding requirement is real, and the underlying investment carries its own risk independent of the tax benefit. This is not a strategy to pursue primarily for the tax benefit, the investment needs to make sense on its own merits.

Strategy 4: C-Corp vs S-Corp Entity Structure

The entity structure of your business at the time of sale significantly affects your tax outcome.

Asset sales vs stock sales. Buyers typically prefer asset sales (they get a stepped-up basis in the acquired assets, which benefits their depreciation schedule). Sellers typically prefer stock sales (they pay capital gains rates on the entire proceeds rather than ordinary income rates on depreciated assets and inventory).

The gap between buyer and seller preferences on asset vs stock sale structure is one of the most negotiated points in lower middle market transactions. The 338(h)(10) election allows a stock sale to be treated as an asset sale for tax purposes in S-corporation transactions, a mechanism that can bridge the buyer/seller preference gap with specific tax implications for each party.

C-corp vs S-corp. If your business is a C-corporation and you are planning to pursue QSBS exclusion under Section 1202 or sell to an ESOP under Section 1042, the C-corp structure is required. If you are planning a straightforward sale without those specific strategies, the S-corp structure typically produces lower overall taxation because it avoids entity-level tax and passes gain directly to shareholders.

The right entity structure is one of the first conversations to have with a CPA who understands M&A, ideally two to three years before you go to market, when there is time to restructure if needed.

Strategy 5: ESOP, Tax-Advantaged Exit to Your Employees

An Employee Stock Ownership Plan is a qualified retirement plan that acquires your company on behalf of employees. For business owners who want a tax-advantaged exit, employee continuity, and the ability to maintain business culture post-close, ESOPs are worth serious consideration.

The primary tax benefit for sellers: C-corporation owners who sell at least 30% of the company’s stock to an ESOP can defer capital gains indefinitely under Section 1042 of the tax code, by reinvesting the proceeds in Qualified Replacement Property. If that property is held until death, heirs receive a stepped-up basis and the deferred gain disappears permanently.

On the company side: a 100% ESOP-owned S-corporation pays no federal income tax on business earnings. The cash flow that would have gone to federal income taxes instead services the ESOP debt and builds employee account values.

The limitations: ESOP transactions require external ESOP financing, annual valuations, and ongoing trustee and administration costs. They also require the seller to accept a fair market valuation, you cannot negotiate a premium above FMV. And the structure is significantly more complex than a straightforward M&A sale.

ESOP exits are appropriate for a specific type of seller: one who values employee continuity highly, is comfortable with the complexity and ongoing administration, and has a C-corporation structure (or is willing to convert). For the right owner, the tax math is extraordinary.

Strategy 6: Pre-Transaction Moves (The Earlier the Better)

Several legitimate tax planning strategies require action before the sale process begins, some as far as two to three years in advance.

Maximize deductible contributions. Cash balance plans and defined benefit pension plans allow business owners to make tax-deductible contributions well beyond the limits of 401(k)s, dramatically reducing taxable income in the years before a sale. A business owner making $1M-$2M annually can sometimes contribute $200K-$500K pre-tax per year through a cash balance plan.

Gift shares to family members. Transferring shares to family members, in trust or directly, before a sale can leverage the annual gift tax exclusion and lifetime exemption, reducing the taxable estate while moving future appreciation out of the estate. This requires estate planning counsel and time, the IRS scrutinizes pre-sale gifts closely.

Charitable strategies. A Charitable Remainder Trust (CRT) accepts appreciated business interests, sells them tax-free, invests the proceeds, pays the donor income for life, and passes the remainder to charity. For owners with charitable inclinations, this can provide income, a partial charitable deduction, and capital gains deferral.

The common thread across all of these: they require planning and time. The week you sign the LOI is not when you discover these options. It is when most of them close.

The CPA Problem (And How to Solve It)

Most business owners have a CPA who handles their annual tax compliance, reviewing financial statements, preparing returns, managing quarterly estimates. That CPA knows your business. They do not necessarily know M&A transactions.

The tax strategies described in this article, installment sales, QSBS planning, QOZ structuring, ESOP transactions, pre-transaction entity and compensation planning, require a CPA who has actually worked through these structures in the context of business sales. The M&A tax space is specialized. A generalist accountant advising on a $12M transaction without specific experience in business sale tax planning can cost a client $1M-$2M in avoidable taxes through well-intentioned but incomplete advice.

Find a CPA who has done this before, specifically in the transaction size range that applies to you. Ask them directly how many business sale transactions they have worked on in the last three years and what strategies they implemented. The answers will tell you whether you have found the right advisor.

Icon Business Advisors works with CPAs who specialize in M&A transactions throughout the Southeast. If you need an introduction, we can point you toward the right resources.

Frequently Asked Questions

What taxes do I pay when I sell my business?

Federal long-term capital gains tax (20% for most sellers at relevant income levels), plus the 3.8% Net Investment Income Tax, for a combined federal rate of approximately 23.8%. Depreciation recapture on previously depreciated assets is taxed at ordinary income rates, which can be as high as 37%. Tennessee has no state income tax on capital gains.

What is the installment sale method for a business sale?

Under Section 453, an installment sale allows you to recognize capital gain over multiple years as you receive payments, rather than recognizing the entire gain in the year of sale. This can reduce peak-year tax exposure and smooth the overall tax burden. Most seller notes in M&A transactions are effectively installment sales.

Does Section 1202 QSBS apply to my business sale?

Only if your business is structured as a C-corporation, the stock was original-issue stock held for at least five years, and the company’s gross assets did not exceed $50 million when the stock was issued. Qualifying businesses can exclude up to $15 million or more in capital gains from federal taxation under the 2025 OBBBA rules.

What is a Qualified Opportunity Zone investment?

A QOZ fund is a private investment vehicle investing in designated census tracts. Reinvesting capital gains into a QOZ fund within 180 days of a sale defers recognition of those gains. If the QOZ investment is held for 10 or more years, the appreciation on that investment is excluded from federal taxation. The OBBBA made these benefits permanent.

Should I talk to a CPA before starting the sale process?

Yes, ideally 12-24 months before you engage an M&A advisor. The strategies that produce the most meaningful tax reduction require advance planning. A CPA who specializes in M&A transactions, not just annual compliance, is the appropriate resource.

Daniel Askew is the Founder and CEO of Icon Business Advisors, a Nashville, Tennessee M&A advisory firm. Icon works with CPAs and tax attorneys across the Southeast to help lower middle market owners structure business exits that minimize unnecessary tax exposure.

Call us directly: (615) 931-0001

---

Complete Guide: How to Sell a Business in Tennessee: A Complete Guide for Owners