How to Report Sale of Goodwill on Form 1120-S: Forms 8594, 4797, and K-1

To report the sale of goodwill on Form 1120-S, the S corporation calculates the gain at the entity level on Form 4797, allocates the purchase price to goodwill on Form 8594, carries the Section 1231 gain (and any Section 1245 ordinary recapture) through Schedule K, and issues each shareholder a Schedule K-1 showing their pro rata share. The corporation itself owes no federal income tax on the gain in most cases; the tax is paid by shareholders on their Form 1040.

Confirm the Goodwill Belongs to the Corporation

Before anything reaches Form 1120-S, decide whether the goodwill being sold is entity goodwill or personal goodwill. Entity goodwill belongs to the S corporation and reflects the business’s reputation, customer base, location, and operating systems. Its sale is a corporate event.

Personal goodwill belongs to the shareholder individually and stems from the owner’s reputation, relationships, and skills. A sale of personal goodwill does not go on Form 1120-S at all. The shareholder reports it directly on Schedule D of Form 1040 as a long-term capital gain, assuming a holding period of more than one year. This matters because personal goodwill bypasses the Section 1231 netting and Section 1245 recapture rules that govern the corporate side.

The asset purchase agreement should allocate separate dollar amounts to each type, backed by an independent appraisal. Where the agreement doesn’t name personal goodwill or no third-party valuation supports the split, the IRS is likely to recharacterize the full amount as entity goodwill and push it back onto the corporate return.

Determine the Corporation’s Basis in the Goodwill

The gain equals the sale price allocated to entity goodwill minus the S corporation’s adjusted basis in that goodwill. Basis depends on how the goodwill came to be on the books.

Internally Generated Goodwill

Goodwill built up through years of operating the business has a tax basis of zero, because the corporation never paid a specific price for it. The entire allocation to entity goodwill in the purchase agreement is taxable gain.

Purchased Goodwill and Section 1245 Recapture

Goodwill acquired when the S corporation bought another business is a Section 197 intangible, amortized ratably over 15 years.¹ Adjusted basis at sale is the original cost minus every year of amortization claimed.

Because that amortization was deducted against ordinary income, the IRS recaptures it as ordinary income when the goodwill is sold. Section 1245 treats the lesser of the total prior amortization or the total gain as ordinary income; only the gain above the recaptured amount is Section 1231 gain eligible for capital gains treatment.² Internally generated goodwill has nothing to recapture, so the entire gain is Section 1231.

When multiple Section 197 intangibles are sold together, they’re treated as one asset for recapture purposes. Losses on some offset gains on others before the recapture calculation runs.²

Allocate the Purchase Price on Form 8594

Both buyer and seller must file Form 8594, Asset Acquisition Statement, when a group of assets making up a trade or business changes hands and goodwill could attach to the deal.³ The form uses the residual method to spread the total price across seven asset classes, starting with cash and ending at Class VII, which is goodwill and going concern value. Whatever price remains after the six higher classes are fully valued is what flows to goodwill.⁴

The seller reports the amount allocated to entity goodwill in Part II of Form 8594 and attaches the form to Form 1120-S for the tax year of the sale. The buyer files a matching copy. Divergent allocations between the two returns invite IRS questions, so the numbers should be negotiated and locked in before either party files.

Report the Sale on Form 4797

Form 4797 is where the corporate gain calculation actually happens. The section of the form you use depends on whether there is prior amortization to recapture.

For purchased goodwill with amortization history, the sale goes in Part III. Lines 19 through 24 carry the sale details, and line 25 calculates the Section 1245 recapture.⁵ The recaptured amount is ordinary income. Any gain above the recapture flows down to Part I as Section 1231 gain.

For internally generated goodwill with no amortization history, skip Part III. The sale goes straight to Part I as a Section 1231 transaction.⁵

In Part I, the goodwill gain is combined with the corporation’s other Section 1231 gains and losses for the year. A net Section 1231 gain is generally long-term capital gain; a net Section 1231 loss is ordinary. The five-year look-back rule then recharacterizes current-year Section 1231 gain as ordinary income to the extent of any unrecaptured net Section 1231 losses from the prior five years.

Push the Gain Through Schedule K and Schedule K-1

Net Section 1231 gain or loss from Form 4797 transfers to Line 9 of Schedule K on Form 1120-S.⁶ Any Section 1245 ordinary recapture income flows separately to the appropriate ordinary income line rather than mixing with the 1231 amount.

Each shareholder receives a Schedule K-1 reflecting their pro rata share. The Section 1231 gain or loss lands in Box 9 of the K-1.⁶ Older references that direct this amount to Box 10 are incorrect; Box 10 covers other categories, and its Code L is currently reserved.⁷

Check for Built-in Gains Tax if Formerly a C Corporation

Most S corporations pay no entity-level tax on a goodwill sale. The exception is a former C corporation that made its S election within the last five years. Under Section 1374, appreciation that existed at the time of the S election is subject to a corporate-level built-in gains tax when the asset is sold during the five-year recognition period.⁸

The tax is imposed at the highest corporate rate under Section 11(b), currently 21%, on the net recognized built-in gain. Any C corporation net operating loss or business credit carryforwards can offset it. After the five-year window closes, the tax no longer applies. The same rule reaches assets the S corporation acquired from a C corporation in a carryover-basis transaction.

Report Installment Sales on Form 6252

If the S corporation receives at least one payment after the close of the sale year, the transaction is an installment sale and gets reported on Form 6252.⁹ Part I sets the gross profit percentage in the sale year, and Part II applies that percentage each year to determine the recognized gain. The form must be filed in the year of sale and every year afterward until the final payment arrives, including any interim year with no payment.

Section 1245 ordinary recapture cannot be deferred. It is fully taxable in the year of sale regardless of the payment schedule.⁹ Larger deals can also trigger an interest charge on deferred tax under Section 453A when the sale price exceeds $150,000 and outstanding installment obligations exceed $5 million at year-end.¹⁰

Each year’s recognized installment gain flows through Schedule K and K-1 the same way a lump-sum sale would, and shareholders pick up their share on their 1040.

Shareholder Reporting on Form 1040

The K-1 amounts are where the tax actually gets paid. The Box 9 Section 1231 amount goes to the shareholder’s own Form 4797, line 2, column (g). Instead of listing property details, the shareholder writes “From Schedule K-1 (Form 1120-S)” across columns (b) through (f).¹¹ The shareholder then combines that amount with any other Section 1231 items on their own return and applies their personal five-year look-back for prior 1231 losses.

A net Section 1231 gain surviving the look-back flows to Schedule D and is taxed at long-term capital gains rates of 0%, 15%, or 20%, based on the shareholder’s taxable income and filing status.¹² Section 1245 recapture flowing through as ordinary income is taxed at the shareholder’s regular rates. A net Section 1231 loss is ordinary and reaches Schedule 1 of Form 1040, where it can offset wages and other ordinary income.

The flow-through items increase the shareholder’s basis in their S corporation stock, which reduces gain on a later sale or liquidation of the shares.

Net Investment Income Tax

Shareholders with modified adjusted gross income above $200,000 (single) or $250,000 (married filing jointly) may owe an additional 3.8% Net Investment Income Tax on the gain.¹³ Whether the goodwill gain counts as net investment income turns on participation. A shareholder who materially participated in the S corporation’s operations generally escapes the surtax on gain from selling business assets; a passive shareholder does not.¹⁴ Those thresholds are not indexed for inflation.

Personal goodwill, if any was allocated in the deal, stays off Form 4797 entirely and goes straight to the shareholder’s Schedule D as a long-term capital gain, separate from anything the K-1 reports.

1
Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles
2
Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property
3
Internal Revenue Service. About Form 8594, Asset Acquisition Statement Under Section 1060
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Internal Revenue Service. Instructions for Form 8594
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Internal Revenue Service. Instructions for Form 4797 (2025)
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Internal Revenue Service. Instructions for Form 1120-S (2025) – Line 9 Net Section 1231 Gain (Loss)
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Internal Revenue Service. Shareholder’s Instructions for Schedule K-1 Form 1120-S (2025)
8
Office of the Law Revision Counsel. 26 USC 1374 – Tax Imposed on Certain Built-in Gains
9
Internal Revenue Service. Form 6252 Installment Sale Income (2025)
10
Internal Revenue Service. Publication 537 (2025), Installment Sales
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Internal Revenue Service. Shareholder’s Instructions for Schedule K-1 Form 1120-S (2025) – Box 9
12
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
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Internal Revenue Service. Topic No. 559, Net Investment Income Tax
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Internal Revenue Service. Questions and Answers on the Net Investment Income Tax