For most sellers, cash at closing beats an equal earnout, because earnout dollars come later, may never come, and can be taxed as wages if tied to your staying. We start every plan by counting the earnout at zero. Essential spending should be covered by after-tax closing cash plus outside savings, and whatever the earnout pays goes to extras, gifts or the next generation.
Take Latoya, a hypothetical owner with a $3.2 million offer that holds 30 percent back as an earnout. Her question is the one clients usually ask: "If the totals match, why does it matter which part comes later?" At Apollon Wealth Management, we answer it one decision at a time, in the order the deadlines fall, with the numbers in front of you. The steps below are checks you run on the offer, each with its reason and what to do if it fails.
By Marcus Thompson, CFA — Wealth Manager | Reviewed by Hiroshi Tanaka, CFPMarcus builds diversified portfolios for high-net-worth clients, with deep expertise in asset allocation and risk management.
I tell sellers to price the earnout at zero and at half. If the plan still works at zero, the earnout is a bonus; if it doesn't, the offer needs more cash.
CFP® and Lead Advisor, Apollon Wealth Management
A retention bonus and purchase price can total the same dollars and still differ by six figures after tax. The wording of the trigger clause decides which one you have.
CPA and Tax Director, Apollon Wealth Management
Spreading payments defers tax; it only saves it when it keeps you out of a higher bracket or Medicare tier.
Senior Financial Planner, Apollon Wealth Management
Step 1: How much of the earnout is purchase price?
Gather the letter of intent and the draft purchase agreement, then find the clause that triggers each earnout payment. If a payment requires you to stay employed, the IRS generally treats it as compensation: ordinary income, plus Social Security tax on wages up to $184,500 (the SSA wage base for 2026) and Medicare tax on all of it.
The buyer usually prefers wage treatment because it can deduct pay but must capitalize purchase price. That's why the label matters to both sides, and why it rarely gets raised for you.
Decide what to ask for. Have the earnout depend on business results, such as revenue or EBITDA, and put any years you stay on under a separate employment agreement at fair pay.
The slip at this step is accepting a "retention bonus" or "consulting fee" label because the total dollars look the same. They aren't the same after tax.
Step 2: How much is the earnout worth if targets slip?
A hypothetical person, Gus, 63, is offered $6 million for his landscaping company: $4.5 million at closing and $1.5 million as an earnout over three years, paid only while he stays on as president. The buyer is a private-equity firm. Say year one hits its target ($500,000), year two hits half ($250,000) and year three misses ($0). He collects $750,000, half the earnout.
Now the tax cost, at illustrative rates. Counted as purchase price at 25 percent, he keeps $562,500 ($750,000 × 0.75). Counted as pay for staying, at 40 percent, he keeps $450,000 ($750,000 × 0.60). The gap is $112,500, and wage treatment adds payroll tax on top.
Before, Gus's plan assumed the full $6 million. After, the core plan rests on after-tax closing cash plus his $700,000 SEP-IRA, and the earnout is counted at zero. Whatever arrives is a bonus.
Here is the method. List each year's target and write honest odds next to it. Private-equity buyers control budgets, hiring and pricing after closing, and an integration can push a target out of reach. Then price the earnout twice: at zero and at half. The calculator on this site lets you plug in your own offer and targets.
Market and business results are never certain, and a portfolio built from closing cash can lose value too. Cash in hand isn't risk-free; it just doesn't depend on someone else's budget.
Gus's numbers, year by year
Pricing it at zero and at half
If your retirement spending only works when the earnout pays out, ask for more cash at closing or an escrowed earnout before the purchase agreement is signed.
Step 3: How long until the last dollar arrives? Dates in calendar order
Start with the letter of intent, where the earnout share is first set. It's usually non-binding, but it anchors everything after it. Next comes the purchase agreement signing, then the closing date, when closing cash is taxed in that year.
After closing, each measurement period ends, and payment follows once the buyer's year-end numbers are final. Each payment year's tax return carries Form 6252 if you use the installment method.
Federal estimated tax falls on April 15, June 15, September 15 and January 15. An earnout check that lands in November drives the January 15 payment, so set the cash aside the day the check clears.
Gus is 63, so the closing year's income sets his Medicare Part B premium two years later, at 65. For 2026 the standard premium is $202.90 a month, and the top joint tier ($750,000 and above) is $689.90 a month.
Step 4: How much does spreading the payments really save?
Spreading saves real dollars only when it keeps some years in lower brackets or below a Medicare surcharge tier. The installment method defers tax on the earnout until each payment arrives; it does not erase it. Otherwise it just moves the same tax cost to later years.
Watch interest. If the agreement states no adequate interest on deferred payments, the tax code treats part of each payment as interest, taxed as ordinary income. Ask the attorney to state interest so the split is known.
You can elect out of the installment method and report the earnout's estimated value in the sale year. If it pays less, the shortfall becomes a capital loss later. That loss offsets capital gains plus only $3,000 a year of other income.
Know which moves shift and which save. A larger SEP-IRA contribution in the closing year shifts tax to the withdrawal years. A charitable gift Gus would make anyway saves tax outright.
| Feature | Installment method | Elect out |
|---|---|---|
| When tax is due | As each payment arrives | Sale year, on estimated value |
| If earnout pays less | No tax on unpaid part | Capital loss later |
| Loss offset limit | Not needed | Gains plus $3,000 per year |
| Cash flow | Tax follows cash | Tax paid before cash |
| Medicare tier risk | Spread across years | Bunched into one year |
| Form involved | Form 6252 | Sale reported on Form 8949 |
Step 5: Check what Deborah and your son inherit if you die mid-earnout
Unpaid earnout payments get no step-up in basis at death. Deborah or the estate reports them as income in respect of a decedent as they arrive. Read whether the earnout accelerates, survives or ends with Gus's employment. If the buyer wants Deborah to keep running payroll, read her employment terms separately; her pay and his earnout shouldn't hang on the same clause. Estate planning for owners covers the wider picture.
Step 6: The sellers for whom a bigger earnout can make sense
The lean toward cash doesn't hold for everyone. A seller in their 40s who plans to stay, controls the targets and has years to recover from a miss can reasonably take more earnout. So can a seller facing an earnout under a tenth of the price, or one fully funded in escrow.
It also fits a seller whose spread-out income truly stays in lower tiers. Gus's alternative, selling to his son over ten years, carries its own payment risk and belongs on the family business succession page.
| If your situation is | Then lean toward | Tax note |
|---|---|---|
| Plan fails without the earnout | More cash at closing | Closing cash taxed in sale year |
| Payment requires you stay employed | Tie it to results instead | Wages: ordinary rates plus payroll tax |
| Buyer controls the targets | Escrow or smaller earnout | Unpaid earnout: no tax, no money |
| You control targets and stay | Earnout can be reasonable | Installment method spreads the gain |
| Age 63 or older at closing | Model Part B two years out | Top 2026 joint tier: $689.90 a month |
Step 7: First moves in order, then a checklist for your own offer
First, read the trigger clause. Then price the earnout at zero and at half. Next, ask the CPA to model it both as purchase price and as wages. Last, counter with more cash at closing or an escrow if the core plan fails without the earnout. Business sale tax planning picks up from there.
If this is you: an offer in hand with 20 percent or more of the price held back. At 30 percent, Latoya clears that threshold easily. Run these against your draft:
- Earnout share of total price
- Trigger tied to results or to your job
- Who controls the budget that drives the target
- Stated interest on deferred payments
- Acceleration on resale or death
- Escrow or parent-company guarantee
The part you can do at the kitchen table, and the part for Apollon Wealth Management
You can price the earnout at zero and at half and run the checklist yourself in an evening. Testing whether the core plan holds without it, modeling purchase-price versus wage treatment with your CPA, and timing the closing year against Medicare tiers is the conversation worth having with Apollon Wealth Management before you counter. Tax rates here are illustrative, state taxes vary, and a tax attorney decides how your agreement's wording is treated.
Count the earnout at zero in your core plan, and let whatever it pays be the extra.
Your questions about earnout vs. cash at closing, answered
My purchase agreement calls part of the price a retention bonus; how is that taxed?
A payment that depends on you staying employed is generally treated by the IRS as compensation, not sale proceeds. That means ordinary income rates plus payroll tax. Ask a tax attorney and CPA to review the wording before signing, because the label and the facts both matter.
When do I owe tax on an earnout payment that arrives two years after closing?
Under the installment method, you owe tax in the year the payment arrives, reported with Form 6252 on that year's return. Estimated tax may be due sooner: a November check drives the January 15 payment, so set the tax cost aside when it clears.
What happens to my earnout if the buyer sells the company before the targets are measured?
Without an acceleration clause, the new owner can restructure the business and the remaining earnout may never be measured, so you collect nothing. Ask for acceleration on a resale, or for an escrow or parent-company guarantee, so unpaid amounts survive a change of owner.
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This content is general information only and does not constitute investment, tax or legal advice tailored to your circumstances. Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. Consult a qualified professional before making any financial or legal decision.