A CPA or tax practice almost always sells as a bundle of assets, and the tax follows the allocation of the price on Form 8594, which you and the buyer both file. Goodwill and the client list, which are most of the price, are long-term capital gain federally at 0%, 15% or 20%, and ordinary income in California at 9.3% to 12.3% plus 1% on taxable income over $1,000,000. Anything allocated to a non-compete covenant, to a consulting agreement or to recaptured equipment is ordinary income on both returns. A married couple who sell for $1,000,000 in cash with $150,000 of other taxable income keep $722,030 after $176,815 of federal tax and $101,155 of California tax, an effective rate of 27.8%. The same couple taking 70% at closing and a 30% seller note over three years at 6% collect $1,036,000 and keep $767,479. Two California rules catch sellers in the closing year: the Franchise Tax Board drops the prior-year safe harbor for estimated tax once your California adjusted gross income reaches $1,000,000, and installment gain on goodwill stays California income after you move out of state.
I am a practicing CPA in Los Angeles and the founding CPA of Wilshire Intelligence Network, which buys established CPA and tax practices across California. I sit on the buyer’s side of these allocations, and the buyer’s interest is not always yours, so read what follows with that in mind. Every rate and threshold below is dated and linked at the end. The after-tax proceeds calculator runs any structure year by year; this article explains what it is doing.
- 01Asset sale, residual method, Form 8594 on both returns. The buyer amortizes goodwill and the covenant over fifteen years under IRC 197 and is indifferent between them. You are not: goodwill is capital gain, the covenant is ordinary income.
- 022026 federal long-term capital gain: 0% to $49,450 single and $98,900 joint, 15% to $545,500 and $613,700, 20% above (Rev. Proc. 2025-32). The 3.8% net investment income tax does not reach the goodwill gain of an owner who materially participates.
- 03California has no capital gain rate. Goodwill gain is taxed on the ordinary schedule, 9.3% across most of the range and 12.3% above $742,953 single or $1,485,906 joint, plus the 1% mental health services tax over $1,000,000.
- 04A seller note or earnout is reported under the installment method on Form 6252 and FTB 3805E: gain as principal arrives, interest as ordinary income. Depreciation recapture on equipment is taxed in full in the closing year regardless of when you are paid.
- 05Closing year: at $1,000,000 or more of California AGI the only safe harbor is 90% of the current year’s tax, so the closing-year estimate must be paid on the sale. Under FTB Publication 1100, installment gain on goodwill sold while you were a resident stays taxable in California after you leave.
The allocation decides the tax: Form 8594 and the seven classes
Under IRC 1060, both sides of an asset sale allocate the price among seven classes in a fixed order, the residual method, and attach Form 8594 to the return for the year of closing. The two forms have to agree. In a CPA practice the first four classes are usually empty or small, so the price lands on equipment, on the intangibles, and on goodwill.
| Class | What it holds in a practice sale | Your tax on it | The buyer’s side |
|---|---|---|---|
| I and II | Cash, deposit accounts, marketable securities. Normally kept by the seller, not sold. | None | None |
| III | Accounts receivable. A cash-basis practice usually keeps them and collects after closing. | Ordinary income when collected, or when sold | Collected at face if bought |
| IV | Inventory. Not present in a practice. | Not applicable | Not applicable |
| V | Furniture, computers, servers, leasehold improvements, a vehicle. | Ordinary income up to the depreciation you claimed (IRC 1245), capital gain on anything above original cost | Depreciated again, often expensed in year one |
| VI | Section 197 intangibles other than goodwill: the client list, the covenant not to compete, workforce in place, the firm name, software and files. | Client list and name: long-term capital gain. Covenant: ordinary income. Purchased intangibles you amortized: ordinary to the extent of amortization | Amortized over fifteen years |
| VII | Goodwill and going-concern value. The residual after everything else. | Long-term capital gain if the practice is more than a year old | Amortized over fifteen years |
Two things follow. First, the buyer has no tax reason to care how much of the price sits on the covenant versus goodwill, because IRC 197 amortizes both over fifteen years. The buyer does care about equipment, which it can write off in the first year, and about a consulting agreement, which it deducts as paid. Every dollar the buyer moves from goodwill to equipment or consulting is a dollar that moves from your capital gain to your ordinary income. Second, the allocation is negotiated, and the place to negotiate it is the letter of intent, before the purchase agreement is drafted around the buyer’s numbers.
What you keep from an all-cash sale
Four inputs give the federal and California tax on a cash sale at closing, at the 2026 federal breakpoints and the current California schedule. Enter other taxable income as the figure after deductions, the way the full calculator’s worked cases do.
Federal $176,815, California $101,155, effective rate 27.8%
Cash at closing, goodwill with zero basis, California resident, no net investment income tax on the goodwill gain. The full calculator adds the seller note, the earnout, equipment, a consulting agreement and the standard deduction, year by year.
Federal: Rev. Proc. 2025-32 ordinary brackets and 0%, 15% and 20% capital gain breakpoints for 2026. California: 2025 Franchise Tax Board rate schedules plus the 1% mental health services tax over $1,000,000; the 2026 schedule is published in the fall. Tax on the sale is the difference between tax with and without the sale. An estimate, not a return position or tax advice.
Goodwill: capital gain federally, ordinary income in California
Goodwill and the client list are capital assets in your hands, and a practice you have run for more than a year gives long-term gain. Self-created goodwill has no basis, so the whole allocation is gain. The federal rate depends on where the gain lands on top of your other taxable income.
| 2026 federal long-term capital gain | Single | Married filing jointly |
|---|---|---|
| 0% | Taxable income to $49,450 | To $98,900 |
| 15% | $49,450 to $545,500 | $98,900 to $613,700 |
| 20% | Above $545,500 | Above $613,700 |
| Net investment income tax, 3.8% | Applies above $200,000 single and $250,000 joint of modified AGI, but not to the gain on goodwill of a trade or business in which you materially participated (Reg. 1.1411-4(d)(4)(i)(A)). It does apply to interest on a seller note. | |
Breakpoints from Rev. Proc. 2025-32. The breakpoints are taxable income, so the standard deduction ($16,100 single, $32,200 joint in 2026) or your itemized deductions come off first.
California does not have a capital gain rate. The gain is added to your other income and taxed on the ordinary schedule, which is where most sellers are surprised: the state takes more than half as much as the IRS does on the same goodwill.
| California rate (2025 schedule) | Single, taxable income | Married filing jointly |
|---|---|---|
| 1% to 8% | To $72,724 | To $145,448 |
| 9.3% | $72,724 to $371,479 | $145,448 to $742,958 |
| 10.3% | $371,479 to $445,771 | $742,958 to $891,542 |
| 11.3% | $445,771 to $742,953 | $891,542 to $1,485,906 |
| 12.3% | Above $742,953 | Above $1,485,906 |
| Mental health services tax, 1% | On taxable income over $1,000,000, either status (R&TC 17043) | |
Franchise Tax Board 2025 rate schedules. The 2026 indexed schedule is published in the fall and moves the breakpoints up a few percent; the rates do not change.
Worked on the $1,000,000 cash sale, married filing jointly, $150,000 of other taxable income, the whole price on goodwill. Federally the gain fills the 15% band from $150,000 to $613,700, which is $463,700 at 15%, or $69,555, and the remaining $536,300 falls at 20%, or $107,260. Federal tax on the sale is $176,815. California taxes the $1,000,000 on top of the $150,000: the slice to $742,958 at 9.3%, then 10.3%, then 11.3% to $1,150,000, plus 1% on the $150,000 over $1,000,000. California tax on the sale is $101,155. Total $277,970, net $722,030, effective rate 27.8%. The same sale by a single filer with $80,000 of other income at a $600,000 price nets $442,048, an effective rate of 26.3%.
One question I ask owners who practice through a corporation. If your practice is an accountancy corporation taxed as a C corporation, an asset sale is taxed twice, 21% federal and 8.84% California inside the corporation, then again when the cash comes out as a dividend. An S corporation passes the gain through to you once, with a built-in gains tax if it converted from C status within the last five years. In either case, the goodwill of a small practice may be yours personally rather than the corporation’s. In Norwalk v. Commissioner, T.C. Memo 1998-279, the Tax Court held that the client relationships of an accounting firm belonged to the individual CPAs, not the corporation, because the accountants had no employment agreement or covenant not to compete with it. Where that holds, the personal goodwill is sold by you directly, once, at capital gain rates. It has to be true on the facts and documented before the letter of intent, not asserted on the return afterwards.
The non-compete covenant
Every purchase agreement carries a covenant not to compete, and in California it is enforceable only because goodwill is being sold with it (BPC 16601). The amount allocated to the covenant is ordinary income to you, up to 37% federally plus the California rate, as the payments arrive. The buyer amortizes it over fifteen years exactly as it amortizes goodwill, so the buyer gains nothing from a large allocation and you lose on every dollar.
On the $1,000,000 couple, moving $100,000 of the price from goodwill to the covenant raises the federal bill from $176,815 to $184,587 and leaves California unchanged, because California taxes both the same way. Moving $50,000 costs $3,500. The covenant should carry a small, defensible allocation that reflects what a buyer would pay for the promise alone, and the purchase agreement should say so in the allocation schedule. A buyer who proposes 15% or 20% of the price on the covenant is proposing to raise your tax for no benefit to itself; ask why.
Equipment, receivables, and the consulting agreement
Three smaller pieces of a practice sale are ordinary income, and two of them are taxed in the closing year whether or not you have been paid.
- Equipment and furniture. Gain up to the depreciation you claimed is recaptured as ordinary income under IRC 1245, reported on Form 4797. Publication 537 is explicit that recapture income is reported in full in the year of sale and is not part of the installment computation, so a seller note does not spread it. Most practice equipment is fully depreciated and worth little; $30,000 of recapture on the $1,000,000 couple costs $2,100 more federal tax than the same amount on goodwill. Keep the equipment allocation at fair value and no higher.
- Receivables and work in progress. A cash-basis practice usually keeps its receivables and collects them after closing as ordinary income, the same as before the sale. If the buyer purchases them, the price is ordinary income to you in the year of sale. Unbilled work in progress sold with the practice is treated the same way.
- The consulting or transition agreement. Compensation for staying one or two seasons is ordinary income, reported on a 1099-NEC if you are paid as a contractor, and carries self-employment tax of 15.3% on net earnings up to the $184,500 Social Security wage base for 2026 and 2.9% above. The buyer deducts it as paid, which is why buyers like to move price into it. A retention holdback is different: if the purchase agreement describes the held-back amount as part of the price for the goodwill, adjusted for retained fees, it is installment gain on goodwill, not compensation. Draft it that way.
- Purchased goodwill you amortized. If you bought the practice, or part of it, the amortization you claimed under IRC 197 comes back as ordinary income under IRC 1245 when you sell, and only the gain above your original cost is capital gain. Enter the unamortized balance as your basis in the calculator.
The seller note and the earnout: the installment method
Any part of the price paid after the closing year is reported under the installment method of IRC 453 unless you elect out. For zero-basis goodwill the mechanics are short: each payment of principal is gain in the year it arrives, and the stated interest is ordinary income. Federally it goes on Form 6252; California conforms and uses Form FTB 3805E. Three points decide whether the note helps you.
The bracket effect. Spreading the gain across years keeps more of it inside the 15% federal band and below the California 10.3% and 11.3% breakpoints. The $1,000,000 couple with 70% at closing and a three-year note for the balance at 6% receive $700,000 in the closing year and $118,000, $112,000 and $106,000 over the next three. They collect $1,036,000 in all, pay $268,521 in federal and California tax including the 3.8% net investment income tax on the interest, and keep $767,479 against $722,030 for all cash. About $36,000 of the difference is the interest itself and the rest is the bracket effect. A 50% note over five years takes the net to $813,595 on $1,090,000 collected.
The interest has to be real. A note that states no interest, or less than the applicable federal rate the IRS publishes monthly, is recharacterized under IRC 483 and 1274: part of each principal payment is treated as interest, which turns capital gain into ordinary income without changing what the buyer pays. State the rate at or above the AFR for the note’s term. Secure the note against the practice assets and a personal guarantee; the installment method defers the tax, not the risk that the buyer stops paying.
Earnouts are contingent payments. A payment that depends on retained fees or revenue after closing is a contingent-price sale under Reg. 15A.453-1(c). The regulation spends most of its length on how to recover basis across uncertain payments: over the stated maximum price if there is one, ratably over the payment period if there is a fixed term but no maximum, and over fifteen years if there is neither. For goodwill with zero basis none of that matters. Each earnout dollar is gain when it is received, and if the earnout never pays, there is no loss to claim because there was no basis. Make sure the purchase agreement calls the earnout part of the price for the goodwill, with interest stated or imputed on the deferred amount, and not a bonus or compensation for your transition work.
Electing out of the installment method, and reporting the fair value of the note or earnout in the closing year, is rarely the better position for a seller: it accelerates the tax into the highest-income year and leaves the collection risk with you. The case for it is narrow, for example a year in which you have a large capital loss to absorb the gain.
The California bill, and the two rules that follow you after closing
The rates above are the easy part. Two Franchise Tax Board rules decide what happens in the closing year and in the years after it, and both are missed more often than the rates.
Estimated tax in the closing year. Federally, a seller whose prior-year AGI was over $150,000 avoids an underpayment penalty by paying 110% of the prior year’s tax in estimates, and can leave the balance to April. California says the same for prior-year AGI over $150,000, then takes the safe harbor away: under the FTB’s high-income rule, a taxpayer whose current-year California AGI is $1,000,000 or more ($500,000 married filing separately) must pay estimates based on 90% of the current year’s tax. A $1,000,000 practice sale puts most sellers over that line, so the California tax on the sale has to be paid in the installments due that year, 30% by April 15, 40% by June 15, none in September and 30% by January 15. A sale that closes in the fourth quarter leaves the earlier installments short unless you use the annualized income installment method on Form 5805, which assigns the gain to the period it arrived. Plan the payment on the day the funds land, not the following April.
Moving out of state after the sale. Under FTB Publication 1100, section C, gain from the sale of intangible property under the installment method is sourced to California if you were a resident when you sold, and stays California income after you move; Example 8 in the publication taxes a former resident on exactly that. Goodwill of a sole proprietorship is intangible property. Only the interest on the note takes your new residence. If you plan to retire to Nevada, Arizona or Texas, the order of events matters: a note signed while you are a California resident is California income for its whole term, and a move before closing is a residency question the FTB audits. Get the sequence from a California tax adviser before the purchase agreement is signed, not after.
One smaller California item. An estimated tax payment above $20,000, or a total tax liability above $80,000, puts you under the FTB’s mandatory electronic payment requirement from then on; a paper check for the closing-year estimate draws a 1% penalty.
Five tax terms to settle before the purchase agreement is drafted
- The allocation schedule, attached to the letter of intent
Price by class: equipment at fair value, a small covenant, receivables kept or priced, the rest goodwill. Both sides commit to file Form 8594 on those numbers.
Letter of intent - The covenant at a defensible minimum
What a buyer would pay for the promise alone. The rest of the restraint comes from BPC 16601 and the sale of goodwill, at no tax cost to you.
Letter of intent - Interest on every deferred dollar
Stated at or above the applicable federal rate on the note, and stated or imputed on the earnout. Otherwise principal is recharacterized as interest.
Purchase agreement - The holdback as price, the consulting agreement as compensation
The retention holdback is a price adjustment on the goodwill. The transition work is a separate agreement at a market rate, with its own term and its own tax.
Purchase agreement - The closing date against the calendar
A December closing puts the whole cash payment in one tax year and leaves the California estimates short. A January closing moves the gain into a new year, and in California the 90-day client notice under 16 CCR 54.3 has to clear before the files move either way. Set the closing date with the tax year and the notice window on the same page.
Purchase agreement
What a sale to WIN looks like on the tax side
Our offers pay the majority of the price in cash at closing, with a retention-linked holdback or a seller note where the structure helps both sides, and the allocation is agreed in the letter of intent, not left to the closing binder. We have no tax reason to push price into the covenant or into consulting, and we do not. A practicing CPA sits on our side of the table, so the Form 8594 conversation is between two people who file the form. The after-tax proceeds calculator runs the structure we propose year by year, and the written valuation we send after the first call shows the terms next to the price so the after-tax number is visible before you decide. For what the practice is worth before tax, start with the practice valuation calculator or the guide to selling a CPA practice in 2026.
Sources
- IRS Form 8594, Asset Acquisition Statement and its instructions (asset classes I to VII); IRC 1060, residual method.
- IRS Publication 537 (2025), Installment Sales: sale of a business, residual method, depreciation recapture reported in full in the year of sale, contingent payment sales; read October 13, 2026. IRC 453; Reg. 15A.453-1(c), contingent payment sales; IRC 483 and IRC 1274, unstated and imputed interest.
- IRS Rev. Proc. 2025-32: 2026 ordinary brackets, standard deduction and long-term capital gain breakpoints.
- IRC 197, fifteen-year amortization of goodwill and covenants; IRC 1245, depreciation and amortization recapture; IRC 1411 and Reg. 1.1411-4(d)(4)(i)(A), net investment income tax and the trade-or-business exclusion; IRC 1374, built-in gains tax.
- Norwalk v. Commissioner, T.C. Memo 1998-279: goodwill of an accounting practice belonged to the individual accountants absent an employment agreement or covenant with the corporation. Martin Ice Cream Co. v. Commissioner, 110 T.C. 189 (1998).
- Franchise Tax Board, 2025 tax rate schedules; Revenue and Taxation Code 17043, 1% mental health services tax; Form FTB 3805E instructions.
- Franchise Tax Board, Estimated tax payments: 110% prior-year rule above $150,000 AGI, the $1,000,000 current-year rule, 30/40/0/30 installments; read October 13, 2026. Mandatory e-pay for individuals, $20,000 payment and $80,000 liability thresholds. Form 5805, annualized income installment method.
- FTB Publication 1100, Taxation of Nonresidents and Individuals Who Change Residency, section C, installment sales of intangible property, Example 8.
- California Business and Professions Code 16601, sale-of-goodwill exception to the non-compete ban; 16 CCR 54.3, 90-day client notice.
- Wilshire Intelligence Network, after-tax proceeds calculator: the worked cases, run with the price on goodwill, zero basis, and other taxable income entered after deductions.
This article is general information for practice owners and is not tax, legal or valuation advice. Federal figures are the 2026 amounts in Rev. Proc. 2025-32; the California schedule is the 2025 schedule pending the Franchise Tax Board’s 2026 release. Worked cases assume a California resident, cash-basis practice, zero basis in goodwill, material participation, and no other items on the return. The personal-goodwill and residency positions depend on facts that must be established before closing; confirm them with your own adviser.
Denis is a practicing tax and accounting professional and the principal of VistaTax, a California practice serving individuals and closely held businesses: individual and business tax preparation, tax planning, bookkeeping, financial reporting and payroll. As WIN’s founding CPA he anchors the licensed side of the structure and sits at the table for every transition. More about WIN’s team.