Ever wondered what happens when you sell your business, and someone mentions “going concern value”? More importantly, is that value taxed as a capital gain or as ordinary income? Understanding this can make a big difference in what you owe the IRS. In this article, you’ll learn what going concern value means, how it’s taxed, and what to watch out for so you don’t get surprised at tax time. Let’s break it down in plain English.

What Is Going Concern Value?

Going concern value is the extra value a business has simply because it’s operating smoothly, with loyal customers, trained staff, working systems, and a reputation. Think of it as the difference between a business that’s up and running and one that’s just a pile of equipment and supplies. If you sold a bakery, for example, the ovens and flour are one thing, but the fact that people walk in every morning for their favorite muffins is another. That ongoing buzz is the going concern value.

Why Does Tax Treatment Matter?

When you sell all or part of your business, the IRS wants its share. But not all income is taxed the same way. Capital gains are usually taxed at lower rates, while ordinary income is taxed at higher rates, just like your paycheck.

If the money you get for selling your business is treated as a capital gain, you might pay less tax than if it’s considered ordinary income. So, knowing whether going concern value falls into the capital gain or ordinary income bucket can have a big impact on your bottom line. This question pops up a lot for business owners, especially when selling the business as a whole or facing situations like eminent domain.

Going Concern Value: Capital Gain or Ordinary Income?

Here’s where it gets tricky. The answer depends on what exactly is being sold and how the sale is structured. In general, if you sell your entire business, including its going concern value, the IRS may treat the gain as a capital gain. But if part of what you’re selling looks more like selling your know-how, a contract, or a service, that part could be taxed as ordinary income.

For example, if you sell the physical assets of your store and the buyer pays an extra amount for your built-in customer base and reputation, that extra could be considered part of the going concern value capital gain ordinary calculation. If, however, you’re getting paid for a non-compete agreement (a promise not to open a similar shop nearby), that payment is usually taxed as ordinary income.

The line isn’t always clear. Sometimes, the IRS and courts look at:

  1. What exactly was sold (assets, goodwill, contracts, etc.)
  2. How the sales agreement is written
  3. Whether intangibles like goodwill or going concern value were included

Most of the time, if the going concern value is part of selling the entire business, it’s treated as a capital gain. If it’s tied to a specific contract, service, or agreement, it could be ordinary income.

Goodwill vs. Going Concern Value

You might have heard the term “goodwill” tossed around with going concern value. They’re related, but not exactly the same. Goodwill is the value of your business’s brand, reputation, and customer relationships. Going concern value is a broader idea, it includes goodwill but also covers things like your team, the systems you’ve set up, and the fact that the business is making money day-to-day.

For tax purposes, both goodwill and going concern value are usually considered capital assets. If you sell your business and part of the price is for these intangibles, that amount is often taxed as a capital gain, not as ordinary income. But, as always, the details matter, and sometimes the IRS sees things differently depending on how the sale is structured.

Practical Examples: How It Plays Out

Let’s say you’re selling your landscaping company. You have trucks, tools, and contracts with clients. The buyer pays you for the equipment (that’s pretty straightforward) and also for your client list and the fact that the business is running smoothly. That “smooth running” part is the going concern value.

If the sales contract says the buyer is paying extra for the ongoing business, the IRS might view that as a going concern value capital gain ordinary question. If that value is rolled into the price for the business as a whole, it’s likely taxed as a capital gain. But if you also get paid separately for consulting or helping the new owner transition, that income could be taxed as ordinary income.

Here’s another example. Suppose the city takes your business under eminent domain, meaning they force you to sell your property for public use. If part of the payment reflects the fact that your business was a going concern (not just the value of the physical property), that part might be taxed as a capital gain. But if the payment is more like compensation for lost income, it could be taxed as ordinary income.

What Should You Do If You’re Selling?

If you’re thinking about selling your business, it’s smart to plan ahead. Here’s what helps:

  1. Work with a tax advisor who understands business sales and going concern value.
  2. Make sure the sales agreement clearly explains what’s being sold, assets, goodwill, going concern value, and any services or agreements.
  3. Be prepared to explain and document how the price was set, especially if there’s a separate value for intangibles.

Proper planning can help make sure you get the best possible tax treatment and avoid surprises. Remember, mistakes in how you structure the sale can lead to paying more tax than you need to.

Conclusion

Knowing whether going concern value is taxed as capital gain or ordinary income can save you money and headaches. The difference often comes down to what’s being sold and how the deal is put together. Want to make sure you get it right? Contact us to learn more.