Capital gains vs. ordinary income on a DTC sale

When a direct-to-consumer (DTC) founder sells, the headline number on the term sheet is only half the story. What you actually keep depends on how the deal is structured, and the gap between two structures on the same price is frequently larger than the gap between two competing bids. A $5M brand sold as stock nets the seller roughly $3.81M after federal tax. The same $5M sold as an asset deal, where inventory and equipment get taxed as ordinary income, can net $800,000 or more less once you account for a C-corp's double tax. This piece walks through where the money leaks, which asset buckets hurt you, and what to model before you sign. If you are still deciding whether to sell at all, start with when to sell your ecommerce brand and then come back here for the structure math.

Why the structure of your sale matters as much as the price

Two founders sell brands for the same $5M. One signs a stock sale and wires himself $3.81M after federal tax. The other signs an asset sale, and depending on his entity, keeps somewhere between $3.01M and $3.59M. Same price, up to an $800K swing. That is the whole point of this article.

The core distinction is simple. In a stock sale (also called an equity sale), you sell the ownership interest in the company itself. If you held it more than a year, essentially the entire gain is long-term capital gain, taxed at a top combined federal rate of 23.8% (20% under IRC Section 1(h) plus the 3.8% net investment income tax under Section 1411). In an asset sale, the buyer purchases the individual assets of the business, and the price gets carved up across asset classes on IRS Form 8594. Some of those classes are taxed at capital-gains rates. Others, notably inventory and recaptured depreciation, are taxed as ordinary income at up to 37%.

When I talk to founders getting ready to sell a brand this size, almost none of them have modeled the after-tax number before the letter of intent lands. They anchor on the headline multiple. The structure conversation happens later, usually after the buyer has already framed it as an asset deal, and by then the seller has lost most of his bargaining power to change it.

The stock sale advantage: one tax, one rate

A stock sale is the cleanest outcome for a seller. You held the equity more than a year (the holding-period test under IRC Section 1222), so the gain is long-term capital gain, taxed once, at one rate.

Run the math on a $5M sale with a $0 basis (conservative, but common for founders who never put much cash in). The entire $5M is long-term capital gain. Federal tax at 23.8% is $1,190,000. Net to the seller: $3,810,000. There is no ordinary-income layer, no depreciation recapture, no allocation fight over inventory. One number, one rate.

The one place this breaks is the C-corp. If a C-corp itself sells its assets, the corporation pays tax on the gain at 21%, and then the shareholder pays again when the cash is distributed. That is the double-tax trap, and it is why standalone C-corp sellers push hard for a stock sale rather than letting the corporation sell assets. A pass-through entity (an LLC or S-corp) does not have this problem, because there is no separate corporate-level tax.

The pattern we see again and again is that the founders who net the most are the ones who forced the structure question early, before the buyer's advisors had drafted the deal as an asset purchase. Once "asset sale" is written into the LOI, negotiating back to a stock sale is an uphill fight, because the buyer gives up real tax benefits to get there.

The asset sale: where ordinary income sneaks in

Buyers like asset sales for two reasons: they get a fresh, stepped-up basis to depreciate going forward, and they leave most of the target's old liabilities behind. IRC Section 1060 governs how the price is allocated, using a residual method across seven asset classes, and both sides report the split on Form 8594.

Here is where it bites the seller. Some classes are ordinary income, some are capital gain:

Asset class (Form 8594)	Typical DTC assets	Seller tax treatment	Rate, top bracket
Class I, Cash	Checking and savings balances	Basis recovery, no gain	0%
Class III, Accounts receivable	Customer invoices, platform AR	Ordinary income above basis	Up to 37%
Class IV, Inventory	Finished goods, FBA stock, raw materials	Ordinary income (IRC 1221)	Up to 37%
Class V, Equipment and FF&E	Warehouse gear, computers, vehicles	Ordinary up to prior depreciation (1245), then LTCG	37% on recapture, then 23.8%
Class VI, Section 197 intangibles	Trademarks, domain, customer lists	Section 1231 long-term gain	23.8%
Class VII, Goodwill and going concern	Brand reputation, customer base	Section 1231 long-term gain	23.8%

Inventory is the one that catches people. Under IRC Section 1221(a)(1), inventory is explicitly not a capital asset, so every dollar of the price allocated to finished goods, raw materials, or Amazon FBA stock is ordinary income. On a $5M exit with $1.5M in inventory, that is roughly $555K in ordinary tax versus about $357K if it were capital gain, a $198K swing from one asset category. Equipment adds another leak: any depreciation you previously took gets recaptured as ordinary income under IRC Section 1245, so the "gain" on your warehouse gear is 37% up to the total you depreciated, not the friendly 23.8%.

The good news lives in Classes VI and VII. Goodwill, trademarks, the domain, the customer list, and going-concern value all get Section 1231 treatment, which for a seller means long-term capital gain. For most DTC brands, these intangibles are 50% to 70% of the purchase price, which is why the picture is not all bad, it just needs to be negotiated.

The $800K question: how big is the gap in practice?

Put the two structures side by side on the same $5M and the money becomes concrete. The table below uses a representative asset mix: about $2.0M taxed as ordinary income (inventory plus receivables plus 1245 recapture) at 37%, and about $2.8M of goodwill and intangibles at 23.8%, with $200K in cash recovered at basis.

Structure	Gross proceeds	Ordinary income tax (37%)	LTCG + NIIT (23.8%)	Total federal tax	Net to seller
Stock sale (stock of LLC/S-corp/C-corp)	$5,000,000	$0	$1,190,000	$1,190,000	$3,810,000
Asset sale, single-tier (LLC/S-corp)	$5,000,000	$740,000	$666,400	$1,406,400	$3,593,600
Asset sale, C-corp (double tax)	$5,000,000	corporate 21% ($1,050,000) + shareholder 23.8% ($940,100)		~$1,990,100	~$3,009,900

So the delta between a stock sale and a single-tier asset sale here is about $216,400 on a pass-through. That is real money, but it is the small version. The large version is the C-corp: 21% corporate tax on the $5M gain before anything is distributed ($1,050,000), then 23.8% again at the shareholder level on the remaining $3,950,000 ($940,100). That combination pushes the total federal tax to about $1,990,100, leaving the C-corp seller with about $3,009,900, roughly $800K less than a clean stock sale.

The rate staircase below is the same story in one view. Every ordinary-income item sits at 37%, every capital item at 23.8%, and the 13-plus-point gap between them is the entire game.

One caveat worth stating plainly: these are models, not quotes. The exact split depends on your real Form 8594 allocation, your basis, and your state. When we sit with a founder and rebuild this on their actual numbers, the shape holds but the size moves, sometimes a lot. Treat the $216K and $800K+ figures as the range you are negotiating inside, not a promise.

Three ways to close the gap

There are three levers, in rough order of how often they actually apply.

Negotiate for a stock sale. This is the direct fix, and it is a fight, because the buyer gives up the basis step-up and takes on more liability risk. Sellers often win it by pricing the concession: offer a slightly lower headline number, or a stronger indemnity, in exchange for stock-sale treatment, because the after-tax swing is usually bigger than the price you give up.

Use a Section 338(h)(10) election. This lets a stock purchase be treated as a deemed asset sale for tax purposes, which can give the buyer the basis step-up while keeping the transaction clean legally. The catch: it is only available when the target is an S-corp or a subsidiary in a consolidated C-corp group, and the buyer must itself be a corporation. For a typical small DTC deal where the buyer is an individual, a family office, or an LLC, this election is simply off the table, so do not build your plan around it without confirming the buyer's structure.

Check QSBS under Section 1202. This is the trump card when it applies. Qualified small business stock in a domestic C-corp, held long enough and meeting the gross-asset and active-business tests, can exclude up to 100% of the gain from federal tax. The One Big Beautiful Bill Act, signed in July 2025, expanded this: the gross-asset ceiling rose toward $75M and a shorter holding period now reaches full exclusion, with a per-issuer cap. If you qualify, QSBS can wipe out the entire stock-versus-asset debate, because your federal tax on the whole $5M could be near zero. It is also the least common, because most DTC brands are LLCs or S-corps, not C-corps, and the holding-period clock does not start until you have qualifying C-corp stock.

When I talk to founders who are two or three years out from selling, this is the conversation that has the highest payoff, because QSBS eligibility is something you can sometimes engineer with enough runway, and almost never fix in the final ninety days.

What to do before you sign a term sheet

The move is not to become a tax expert. It is to get the after-tax number in front of you before the structure is locked. A short checklist:

1. Confirm your entity type and default structure. LLCs and S-corps usually sell as assets by default; a C-corp seller almost always wants stock. Knowing which world you are in tells you which fight matters.
2. Model the after-tax delta early, before the LOI, not after. Once "asset sale" is in the signed letter of intent, you have given away most of your bargaining power to change it. Run the stock-versus-asset math while the terms are still soft.
3. Pressure-test the Form 8594 allocation. Every dollar pushed from inventory toward goodwill is a dollar that drops from 37% to 23.8%. The allocation is negotiated, and buyers will happily over-allocate to inventory if you let them, because it helps their future deductions.
4. Check QSBS eligibility now. If there is any chance you are a qualifying C-corp, or could convert with enough lead time, that single question can be worth more than the entire structure negotiation.
5. Layer in state tax. Everything above is federal only. California adds 13.3% on both ordinary income and capital gains; Texas and Florida add nothing. A complete after-tax number requires the state overlay, and it can move the answer by hundreds of thousands of dollars.

Get an M&A-focused tax advisor, or an interim CFO who runs sell-side prep, to run these scenarios before you counter the term sheet, not after you sign it. The cost of that modeling is a rounding error against a six-figure structure swing. And if the headline number itself is what you are trying to move, the levers that increase your exit multiple work best when you start well before the deal.

On a $5M exit, the difference between a stock sale and a C-corp asset sale is roughly $800K in federal tax, and none of it shows up in the headline price. Structure is the negotiation. Model it before the LOI, or you are negotiating with your bargaining power already spent.

Sources and methodology

All dollar figures here are illustrative models, not audited results. The $5M scenarios apply the cited IRC sections to a representative Form 8594 allocation. Real deals vary materially by asset mix, basis, entity type, and state, so treat the numbers as a range to negotiate inside and confirm your own with an advisor.

Long-term capital gains and the net investment income tax come from IRS primary guidance. The 20% top LTCG rate and the 3.8% NIIT (combined 23.8%) are set out in IRS Topic No. 409 and IRS Topic No. 559; the NIIT thresholds ($200,000 single, $250,000 MFJ) have been fixed since 2013.

Asset-sale allocation follows Section 1060 and Form 8594. The seven asset classes, the residual method, and which classes produce ordinary income versus capital gain are drawn from the IRS Form 8594 Instructions and IRS Publication 544.

Inventory, receivables, recapture, and intangibles are governed by named code sections. Inventory's ordinary treatment is IRC Section 1221; depreciation recapture is IRC Section 1245; Section 197 intangibles and goodwill receive Section 1231 capital treatment under IRC Section 197.

QSBS figures reflect the 2025 statutory changes. The expanded gross-asset ceiling, shorter holding period for full exclusion, and per-issuer cap under IRC Section 1202 are summarized in this Baker Tilly analysis of the One Big Beautiful Bill Act changes to Section 1202. These provisions are recent and subject to further IRS guidance.

Frequently asked questions

what's the difference between capital gains and ordinary income when i sell my business?

Capital gains apply to assets you held more than a year, like company stock, goodwill, and your brand, and top out at a combined 23.8% federal rate for high earners. Ordinary income applies to things like inventory and recaptured depreciation and is taxed at up to 37%. Same dollar, very different tax, depending on which bucket it lands in.

how does an asset sale vs stock sale change how much tax i pay?

In a stock sale you sell the whole entity, so 100% of the gain is usually long-term capital gain at 23.8%. In an asset sale the price gets split across asset classes on Form 8594, and inventory, receivables, and depreciation recapture get taxed as ordinary income. On a $5M deal that split can cost you $200K+ on a pass-through entity, and far more on a C-corp.

do i pay capital gains tax on inventory when i sell my ecommerce brand?

No. Inventory is specifically excluded from capital-asset treatment under IRC Section 1221(a)(1), so any purchase price allocated to your finished goods, raw materials, or FBA stock is taxed as ordinary income at up to 37%. It is usually the biggest single ordinary-income line in a DTC asset deal.

what is the net investment income tax and does it hit my business sale?

The net investment income tax is an extra 3.8% federal tax on investment income, including most capital gains, once your modified adjusted gross income passes $200,000 single or $250,000 married filing jointly. On a multimillion-dollar exit you will almost always be over that threshold, which is why the effective long-term rate is 23.8% and not 20%.

how much of my $5 million sale will i actually keep after taxes?

Federally, a clean stock sale nets roughly $3.81M. A typical single-tier asset sale nets around $3.59M, and a C-corp asset sale with double tax (21% corporate plus 23.8% shareholder) nets about $3.01M. State tax comes off the top of all three, so a California seller keeps materially less than a Texas or Florida seller.

what is section 1245 depreciation recapture and how does it hit me in a deal?

If you depreciated equipment (warehouse gear, computers, vehicles) before the sale, Section 1245 claws that depreciation back as ordinary income when you sell, up to the total gain on that equipment. Only gain above your original cost gets capital-gains treatment, so recapture quietly converts what feels like a capital gain into a 37% item.

is my ecommerce brand eligible for the qsbs exclusion under section 1202?

Only if it is a domestic C-corp that meets the tests: original-issuance stock, a gross-asset cap at issuance, an active qualified business, and a minimum holding period. If you qualify, Section 1202 can exclude up to 100% of the gain from federal tax, which is why it is worth checking before you ever restructure. Most pass-through DTC brands are not eligible without converting first.

why do buyers want an asset sale and sellers want a stock sale?

Buyers prefer asset deals because they get a stepped-up basis to depreciate and they leave most legacy liabilities behind. Sellers prefer stock deals because the whole gain is capital and there is no ordinary-income drag. That tension is exactly what you are negotiating when you argue over deal structure, and the gap is often worth more than a bump in headline price.