Tax Implications of Selling Your LLC in 2025
Selling your LLC in 2025 could result in a significant payday—but it also comes with important tax consequences. Whether you’re selling to a...
8 min read
If your LLC is taxed as an S-Corporation, selling the business comes with unique advantages—but also some important differences you need to understand. The S-Corp tax election impacts everything from how the sale is structured to what kind of taxes you'll owe.
Legal GPS Pro
Protect your business with our complete legal subscription service, designed by top startup attorneys.
- ✅ Complete Legal Toolkit
- ✅ 100+ Editable Contracts
- ✅ Affordable Legal Guidance
- ✅ Custom Legal Status Report
In this guide, we’ll walk through how S-Corp tax treatment changes the selling process, what pitfalls to watch out for, and how to plan for the most tax-efficient exit.
1. What It Means to Be an LLC Taxed as an S-Corp
At its core, this setup is a combination of legal flexibility and tax efficiency. You’ve formed an LLC under state law, but you’ve elected to be taxed as an S-Corporation with the IRS (using Form 2553). This doesn’t change your LLC’s legal structure—but it does change how the IRS treats your profits, losses, and ultimately, the sale of your business.
Why Owners Make the S-Corp Election
- To reduce self-employment taxes by splitting income into salary and distributions
- To avoid the double taxation that comes with a C-Corp
- To maintain operational flexibility while benefiting from pass-through taxation
But when it comes time to sell, that election can create very different outcomes depending on how the deal is structured.
Pro Tip – The IRS Treats You Like a Corporation for Tax Purposes—Even if You're Still an LLC
Once you’ve made the S-Corp election, the IRS expects you to follow corporate tax rules—even though your LLC still operates under state LLC laws. This means you’ll be dealing with things like Form 1120-S, capital stock treatment, and purchase price allocation rules that don’t typically apply to standard LLCs.
2. Asset Sale vs. Stock Sale: What’s Allowed and What’s Best
One of the biggest questions when selling an LLC taxed as an S-Corp is whether to structure the deal as an asset sale or a stock-equivalent sale (technically, a sale of your LLC membership interest). Each path has different tax implications—and buyers and sellers often have competing preferences.
Asset Sale: Preferred by Buyers
In an asset sale, the buyer purchases specific business assets (equipment, goodwill, contracts) and possibly assumes certain liabilities, but not your LLC’s legal entity itself.
Why buyers like it:
- They get a step-up in basis in the purchased assets, which allows for new depreciation deductions.
- They avoid inheriting your business’s past liabilities or legal risks.
Why sellers don’t love it:
- You’ll pay tax on the gain from each asset sold. Some of that gain—like depreciation recapture—will be taxed at ordinary income rates, not capital gains.
- You may face multiple layers of taxation on different asset classes depending on your basis.
Membership Interest Sale: Preferred by Sellers
Although S-Corps technically issue stock, your LLC taxed as an S-Corp uses membership interests. Selling that interest is functionally similar to a stock sale: the buyer purchases your ownership stake and steps into your position as the owner of the entity.
Why sellers like it:
- Most or all of the gain is taxed as long-term capital gain, assuming the interest has been held for over a year.
- It’s usually simpler and may allow you to avoid ordinary income traps tied to asset sales.
Why buyers resist it:
- They inherit the LLC’s liabilities, contracts, and historical tax exposure.
- They don’t get a basis step-up in the assets unless the deal qualifies for a Section 338(h)(10) election (more on that in later sections).
Example – Comparing Tax Outcomes on a $500K Deal
Let’s say your LLC taxed as an S-Corp sells for $500,000:
- Asset sale: $150,000 is allocated to depreciated equipment and triggers depreciation recapture taxed at ordinary income rates. The rest is taxed as capital gains. Net after-tax result: significantly reduced by ordinary income tax.
- Membership interest sale: Entire $500,000 is treated as long-term capital gain, with lower tax rates and no recapture.
3. Tax Benefits of the S-Corp Structure in a Sale
One of the main advantages of selling an LLC taxed as an S-Corp is the ability to avoid double taxation, a burden typically faced by C-Corps. S-Corps are treated as pass-through entities, which means the income from the sale flows directly to the owner’s personal tax return. This structure allows for more favorable tax treatment—especially when the sale is structured strategically.
Key Tax Benefits for Sellers
- No Corporate-Level Tax Unlike C-Corporations, which pay taxes on the sale proceeds at the corporate level before distributing profits to shareholders (who are then taxed again), S-Corp sellers are only taxed once at the individual level. This alone can result in tens of thousands of dollars in savings.
- Capital Gains Treatment on Membership Interest Sales If you sell your membership interest (as opposed to assets), the entire gain is typically taxed as long-term capital gain, assuming you've held the interest for more than one year. In 2025, that means a maximum federal rate of 20%, plus 3.8% NIIT for high earners—far less than the ordinary income tax rates that apply to asset sales.
- Potential to Reduce Self-Employment Tax If part of your exit involves taking final distributions or consulting for a short time after the sale, your S-Corp setup may allow you to avoid paying self-employment tax on some of that income, depending on how it's structured.
Pro Tip – Selling Ownership Interest = Capital Gains in Most Cases
When selling an S-Corp membership interest (rather than individual assets), you usually avoid depreciation recapture and other income-tax traps. As long as the buyer is eligible and willing to purchase the interest directly, this route can result in the cleanest, most tax-efficient outcome.
4. Depreciation Recapture and Ordinary Income Traps
Even with the S-Corp’s tax advantages, not every part of a sale qualifies for favorable treatment. If your LLC taxed as an S-Corp is sold through an asset sale—which many buyers prefer—you’ll likely encounter depreciation recapture and other ordinary income triggers that can increase your tax liability significantly.
Legal GPS Pro
Protect your business with our complete legal subscription service, designed by top startup attorneys.
- ✅ Complete Legal Toolkit
- ✅ 100+ Editable Contracts
- ✅ Affordable Legal Guidance
- ✅ Custom Legal Status Report
What Is Depreciation Recapture?
Depreciation recapture occurs when you sell an asset (like equipment or furniture) for more than its depreciated value. The IRS requires you to “recapture” the depreciation previously claimed as a tax deduction and pay ordinary income tax on that amount.
Example
- You bought equipment for $50,000 and claimed $40,000 in depreciation.
- You sell it as part of the business sale for $45,000.
- The $40,000 of prior depreciation is recaptured and taxed at your ordinary income rate, not the lower capital gains rate.
Other Ordinary Income Traps in an Asset Sale
- Accounts receivable are treated as income and taxed at ordinary rates.
- Inventory is not a capital asset—it’s taxed as ordinary income when sold.
- Covenants not to compete (if separately valued) may also be taxed as ordinary income.
These traps can result in a blended tax rate, where part of your sale is taxed at 15–20% (capital gains) and other parts at 32–37% (ordinary income), depending on your bracket.
Example – How Depreciation Recapture Changed a Seller’s Tax Bill
Tom sold his LLC taxed as an S-Corp for $800,000 in an asset sale. Of that amount, $250,000 was allocated to equipment and leasehold improvements he’d heavily depreciated. He was surprised to learn that over $180,000 of that was subject to ordinary income tax, not capital gains—increasing his federal tax bill by nearly $40,000 compared to what he had expected.
5. Allocating the Purchase Price and Filing Form 8594
When selling an LLC taxed as an S-Corp—especially through an asset sale—how you and the buyer allocate the purchase price can significantly impact your tax outcome. The IRS requires both parties to agree on and report this allocation using Form 8594, and different asset classes are taxed differently.
Why Purchase Price Allocation Matters
The IRS doesn’t just look at the total amount you received—they care about how it’s divided among specific types of assets. Each asset class is taxed at different rates, so the more that’s allocated to capital assets like goodwill, the better your potential tax treatment.
Buyers and sellers often have competing goals:
- Buyers want allocations toward depreciable assets (e.g., equipment), which they can write off quickly.
- Sellers want allocations toward goodwill or other capital assets to take advantage of long-term capital gains rates.
How Form 8594 Works
Form 8594 breaks the purchase price into seven IRS-defined classes of assets, including:
- Class IV: Inventory (ordinary income)
- Class V: Equipment and tangible personal property (ordinary income or depreciation recapture)
- Class VI: Intangibles (like customer lists)
- Class VII: Goodwill and going-concern value (long-term capital gains)
Both the buyer and seller must file matching versions of Form 8594 with their tax returns. If the IRS sees a mismatch, it could trigger an audit or delay.
Pro Tip – Negotiate Early
Negotiate the purchase price allocation early in the deal process, ideally at the LOI (Letter of Intent) stage. The longer you wait, the harder it becomes to shift the allocation—and the more likely it is that tax consequences won’t be in your favor.
6. S-Corp Limitations and Gotchas
While selling an LLC taxed as an S-Corp can be tax-efficient, there are specific IRS rules and restrictions that can trip you up if you're not prepared. These “gotchas” usually relate to who can buy the business, how long your S-Corp election has been active, and how the deal is structured.
1. Built-In Gains (BIG) Tax if You Converted from a C-Corp
If your LLC used to be taxed as a C-Corp and recently made the S-Corp election, you may be subject to the Built-In Gains Tax. This tax applies if:
- The conversion happened within the past 5 years, and
- You sell appreciated assets that existed at the time of conversion.
The IRS treats the gain as if the old C-Corp sold the assets—so even under S-Corp treatment, you could face a 21% corporate-level tax on that gain, in addition to shareholder-level tax.
2. Buyer Eligibility Rules
The IRS imposes strict limits on who can own shares or membership interests in an S-Corp. Your buyer must be:
- A U.S. citizen or resident alien
- An individual, not a partnership or corporation (with few exceptions)
- Not a foreign person, most trusts, or LLCs taxed as partnerships
If your buyer doesn’t qualify, the sale could cause your S-Corp election to automatically terminate, triggering unexpected tax consequences and potentially converting your business back into a C-Corp—with double taxation.
3. Ownership Limitations
S-Corps are limited to 100 shareholders and can only issue one class of stock (or one class of membership interest). You can’t:
- Sell preferred shares, or
- Divide ownership into voting and non-voting classes with different economic rights
If your buyer wants a unique deal structure, make sure it doesn’t violate these limitations, or you could risk losing your S-Corp status.
Pro Tip – Double-Check Buyer Eligibility Before Accepting an Offer
Even if a buyer is offering a great price, verify that they’re eligible to own an S-Corp before you move forward. A quick eligibility check with your CPA or attorney can save you from triggering costly penalties or a status change.
7. Planning Ahead for a Tax-Efficient Exit
The most valuable step you can take when selling an LLC taxed as an S-Corp is planning ahead—ideally months or even a year before you list the business. With the right strategy and timing, you can reduce your tax burden, avoid costly surprises, and walk away with a larger net payout.
Steps to Prepare for a Tax-Smart Sale
- Meet with a tax advisor early – A CPA who understands business sales and S-Corp structures can help model the sale, anticipate tax consequences, and identify red flags.
- Review your entity history – If you recently converted from a C-Corp, check for built-in gains exposure.
- Clean up your financials – Accurate, well-organized books make it easier to justify your asking price and simplify tax reporting.
- Negotiate allocation early – Don’t wait until closing to hash out how the purchase price is allocated. Aim to include it in the LOI.
- Vet your buyer – Ensure they’re eligible to own an S-Corp interest and that your deal won’t violate ownership rules.
Example – How Early Planning Saved a Seller From Built-In Gains Tax
Melissa converted her consulting firm from a C-Corp to an LLC taxed as an S-Corp in 2022. In 2025, she was ready to sell. With her CPA’s help, she structured the deal to exclude assets with large unrealized gains that had existed at the time of conversion. As a result, she avoided tens of thousands of dollars in built-in gains tax that would have applied if those assets had been sold.
Conclusion
Selling an LLC taxed as an S-Corp can be a smart move—offering pass-through taxation, capital gains treatment, and a single layer of tax. But the same S-Corp rules that make it efficient can also create pitfalls if you're not prepared.
From purchase price allocation and depreciation recapture to ownership limits and built-in gains tax, understanding these details helps you protect your payout and avoid IRS trouble.
Before signing a letter of intent or drafting a purchase agreement, meet with a qualified tax advisor. The right guidance can help you structure the sale properly, minimize tax exposure, and ensure a clean, profitable exit.
Do you need a lawyer for your business?
The biggest question now is, "Do you need a lawyer for your business?” For most businesses and in most cases, you don't need a lawyer to start your business. Instead, many business owners rely on Legal GPS Pro to help with legal issues.
Legal GPS Pro is your All-In-One Legal Toolkit for Businesses. Developed by top startup attorneys, Pro gives you access to 100+ expertly crafted templates including operating agreements, NDAs, and service agreements, and an interactive platform. All designed to protect your company and set it up for lasting success.
Legal GPS Pro
Protect your business with our complete legal subscription service, designed by top startup attorneys.
- ✅ Complete Legal Toolkit
- ✅ 100+ Editable Contracts
- ✅ Affordable Legal Guidance
- ✅ Custom Legal Status Report
How to Sell a Portion of Your LLC Ownership
Selling a portion of your LLC ownership allows you to bring in new partners, raise capital, or reduce your involvement in the business while...
Exit Strategies for LLCs With No Clear Buyer
Selling an LLC is easy when buyers are lined up—but what if there’s no one waiting to take over? Many business owners assume their company will be in...