At 70 With $1.2 Million, He’ll Sell His Small Business to a Longtime Employee and Get Paid Over Time. The IRS Lets Him Spread Out the Tax

He told her after closing time one evening. “I want you to have this place.” She’s been with him longer than anyone else on the payroll, knows the customers and suppliers, and knows where every key hangs. What she doesn’t have is a bank willing to lend her the full price.

So he’s 70, and he’ll play banker himself. She pays something up front and sends monthly checks for several years. He also has $1.2 million in retirement savings outside the business. Plenty of owners hand off a shop this way. Spreading out the tax is the easy part to understand. The harder part is the share of his retirement he’s willing to tie to her success.

How Monthly Checks Spread the Tax Out

An installment sale is any sale. At least one payment arrives after the close of the tax year in which the sale happens. Her promise to pay goes into a promissory note, a signed IOU that spells out the amount, the interest rate, and the payment schedule.

Tax on the profit comes due gradually as payments arrive. He reports a portion of the gain. This happens with each payment, in the same proportion the total profit bears to the total price^[1].

Here’s an example. Say the price is $600,000 and his tax basis (about what he has invested in the business, after depreciation) is $150,000. That’s a $450,000 gain, so 75% of every principal dollar he receives counts as profit. A $120,000 down payment means $90,000 of gain in year one. Spread the rest over eight years, and he receives $60,000 of principal a year, with $45,000 of that taxed as gain.

Pieces of the Sale That Can’t Wait

Some dollars get taxed right away:

1. Depreciation recapture. He wrote off equipment over the years. Gain from that equipment is taxed as ordinary income in the year of sale, even if no payments are received that year. A shop full of fully depreciated tools can leave him with a tax bill bigger than the down payment.
2. Inventory. Stock on the shelves is excluded from installment sale treatment^[1], so that part of the price is taxed right away.
3. Interest. The interest she pays is taxed separately, as ordinary income, at his regular rate. It never gets capital gains treatment.
4. Minimum rate. If he charges her less than the applicable federal rate, the IRS treats part of the price as unstated interest. That turns some of his capital gain into ordinary income. A sweetheart rate doesn’t work.

That’s why the way they split the price matters so much, because goodwill, equipment, and inventory each get taxed differently. Once the buyer and seller agree on the split in writing, it’s binding on both of them^[2] unless the IRS objects.

Medicare Premiums Make the Strongest Case for Spreading It Out

Medicare charges higher Part B premiums when income tops certain levels. Medicare looks at your tax return from two years ago. A single filer pays the standard $203^[3] a month up to $109,000 of income ($218,000 for joint filers). At 2026 Medicare rates, a $450,000 gain would put a single filer in the $649.20 monthly Part B tier, plus a Part D surcharge, assuming no other income.

Spreading out the gain keeps most years far lower. He still has to add up everything: interest, Social Security, and IRA withdrawals once RMDs start. For anyone born from 1951 through 1958, that’s age 73. Since he’s past full retirement age, the earnings test no longer applies. Still, more income can make more of his benefit taxable.

Protecting His Money If She Stops Paying

A security interest gives him a legal claim on the business assets, so he can take them back if she defaults. A personal guarantee makes her personally liable for the debt too. Both offer little protection if the business is struggling. His income now partly depends on how well she runs the place.

If he dies before the note is paid off, his heirs take over the remaining gain^[4] and owe the tax on it.

Which Path Fits Most Owners in His Shoes

An installment sale can make sense for a seller with $1.2 million in other savings, provided those savings cover his living costs. The note just adds income on top, and the lower Medicare premiums and lower tax rates are a real benefit.

The installment sale gets riskier when the note makes up a big share of everything he has. In that case, he should push for a bigger down payment and a shorter term. Taking a little less tax deferral in exchange for less exposure to her is a good trade.

One Move Before He Signs

He should have a business lawyer draft the note, the security agreement, and the guarantee. A tax pro should then run the price split, calculate the recapture, and set the interest rate. The usual mistake is an informal note at a below-market rate with no collateral. That costs him in taxes, and it leaves him exposed if she can’t pay.

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