Staying On Post-Sale: Compensation, Earn-Outs, and Non-Competes

If you're staying with the business after the sale, allocate compensation carefully between purchase price and wages. Earn-outs and non-competes create ordinary income.

Compensation versus purchase price matters enormously. Payments classified as wages or consulting fees are ordinary income subject to income tax and self-employment or payroll taxes. Payments classified as purchase price are capital gains. The buyer often prefers to allocate more to compensation (deductible for them), while you prefer purchase price (lower tax rate for you). Form 8594 governs the allocation for asset sales.

Earn-outs create timing uncertainty. Contingent payments based on future revenue or milestones may be treated as installment sale income under Section 453 or as ordinary compensation, depending on how the agreement is structured. The IRS scrutinizes earn-outs closely when the seller stays on as an employee.

Non-compete payments are ordinary income. Under Section 197, the buyer amortizes non-compete payments over 15 years. For you, these payments are taxed as ordinary income regardless of how the rest of the deal is structured.

The pitfall: A poorly drafted post-sale agreement can reclassify what you expected to be capital gains into ordinary income. A CPA should review the deal terms before you sign, not after.