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To intelligently negotiate a sale of your business, you need an idea of how much federal income tax you’ll owe. Your tax bill can be quite substantial if you’ve owned your business for a while and it has increased in value over the years.

The rules for computing the tax on the sale of a business can be extremely complicated, so you’ll want to consult with a CPA to get an accurate projection. But it helps to know some of the basic concepts.

» The key factors that affect your tax bill are:

The type of legal entity you’ve chosen for your business. For example, the tax consequences will be different for a C corporation than for an S corporation, a limited liability company (LLC), a partnership, or a sole proprietorship.

How your sale is structured. The big issue here is whether you sell your business as an entity or sell its assets. This can be especially significant if you own a C corporation because a sale of the corporation assets – rather than the corporation itself – can trigger double taxation.

Whether the sale price is paid in one lump sum or is spread over a number of years. If you receive full payment when you sell your business, your gain will be taxed all at once. By contrast, if you sell your business on an installment payment basis, your immediate tax liability will be limited. If you receive payments in years when your overall income is less than it is now – often the situation if you’re retiring – you’ll pay tax in a lower tax bracket, meaning you’ll keep a larger percentage of the sale price.

Capital gains vs. ordinary income. When you sell your business through an asset sale, you’ll need to allocate the sale price among the different categories of assets established by the IRS. How you allocate the sale price can have a major effect on your tax liability. The gain on some assets will be taxed at ordinary income rates. The gain on other assets will be taxed at the lower long-term capital gains rates.

Whether you’ll receive compensation in future years for work you do for the buyer. You may agree to continue working for the business after the sale – either as an employee or an independent contractor. If so, you may be willing to agree to a lower sale price if you’re confident that you’ll be earning generous compensation in the years ahead. This may result in your paying lower taxes overall, especially if you’ll be in a lower tax bracket in the future. But remember that your earnings will be taxed at ordinary income rates rather than capital gain rates. And you’ll need to pay all or a portion of the Social Security and Medicare taxes.

Your CPA can explain in greater detail how these factors will apply to your own situation.

Now let’s look a bit more at the allocation of the purchase price when you sell the assets of your business rather than the entity itself.

The IRS expects you and the buyer to allocate the sale price among various asset classes. As the seller, you’ll want to allocate most of the sale price to assets on which you’ll pay tax at the capital gain rate. The buyer, however, will want to assign the bulk of the sale price to assets that can be immediately written off or can be rapidly depreciated.

The allocation of the sale price will probably become part of your negotiations with the buyer.

As the seller, you’d like to see most of the purchase price allocated to “capital assets.” In general terms, these are assets that last a while. This includes depreciable equipment, such as tools, furniture, manufacturing machines, computers, and vehicles. It also includes real estate, goodwill, and some intellectual property such as copyrights.