Usually as capital gain if it is additional purchase price for the practice, paid because the practice hit a revenue or profit target. Part of each payment is treated as imputed interest and taxed as ordinary income. If the earnout is conditioned on you personally staying employed, the IRS can treat it as compensation for services, which means ordinary income at up to 37 percent plus payroll tax. The words of the agreement decide which one it is.
" - q: "What is the installment method?" a: "It is the default rule under Section 453 for a sale where at least one payment comes after the year of sale. You compute a gross profit ratio, which is your total gain divided by the total contract price, and report that share of each payment as gain when you receive it. The rest of each payment is a return of your basis. If your basis is near zero, as it is for most physicians who built their practice, nearly all of each payment is gain.
" - q: "How is an earnout with no maximum taxed?" a: "Under Temp. Reg. 15A.453-1(c). If the agreement states a maximum total price, you recover your basis as if that maximum will be paid. If there is no maximum but there is a fixed period of payments, you recover basis evenly over that period. If there is neither a maximum nor a fixed period, you recover basis over 15 years. Treating the sale as an open transaction under Burnet v. Logan, where you recover all basis first, is allowed only in rare cases.
" - q: "Can I choose not to use the installment method?" a: "Yes. Section 453(d) lets you elect out on a timely filed return for the year of sale. You then report the full fair market value of the note or earnout right in the year of sale. Sellers sometimes do this when they expect to be in a higher bracket later, when they want to use a large deduction or loss this year, or when they want to avoid the Section 453A interest charge entirely. The election is hard to undo, so model it first.
" - q: "What is the Section 453A interest charge?" a: "It is an interest payment you owe the IRS for deferring tax on a large installment sale. It applies if you hold more than $5 million of installment obligations at the end of the year from sales with a price over $150,000. You multiply the tax you deferred by the share of your obligations above $5 million, and then by the IRS underpayment rate. The result is added to your tax bill and is not deductible. It repeats every year the obligations stay outstanding above the threshold.
" - q: "Is depreciation recapture on my equipment deferred too?" a: "No. Section 453(i) requires the recapture portion of your gain, the ordinary income from equipment you wrote off under bonus depreciation or Section 179, to be recognized in the year of sale even if you have not been paid for it yet. If a large part of the price is deferred, you can owe tax on recapture with little cash in hand to pay it.
" - q: "What happens to my seller note if the buyer goes bankrupt?" a: "You are an unsecured creditor, usually behind the platform's lenders. Envision, backed by KKR, filed for Chapter 11 in May 2023 and emerged owned by its lenders. Prospect Medical Holdings, backed by Leonard Green, filed in January 2025. In a bankruptcy, unsecured seller notes and earnout rights are often paid little or nothing. Meanwhile you may already have paid tax on recapture and on payments you did receive. Treat a seller note as a loan to the buyer, because that is what it is.
" - q: "If I move to Florida after closing, does California still tax my earnout?" a: "Yes, if you were a California resident when the sale happened. California rule 18 CCR 17952 says that gain from later installment payments on a sale of intangible property is sourced to California if you were a resident at the time of sale. Moving after closing does not shelter the seller note or the earnout. New York applies a similar rule to installment payments from a New York-source sale.
" llms_summary: "Explains the 2026 tax treatment of seller notes, holdbacks, and earnouts in a physician practice sale to private equity. Covers the installment method under Section 453, the contingent payment rules of Temp. Reg. 15A.453-1(c) (stated maximum, fixed period, or 15 years), imputed interest under Sections 483 and 1274 as ordinary income, recharacterization of employment-linked earnouts as compensation with payroll tax, Section 453(i) recapture recognized in year one, and electing out under Section 453(d). Works through the Section 453A interest charge, which applies when installment obligations from sales over $150,000 exceed $5 million at year end, computed as deferred tax times applicable percentage times the Section 6621 underpayment rate and nondeductible for individuals, with an illustration. Also covers buyer credit risk (Envision, Prospect) and California's trailing rule in 18 CCR 17952." ---In 2025 and 2026, private equity buyers have been pushing more of the purchase price into pieces you receive after closing: rollover equity, earnouts, holdbacks, and seller notes. Deal volume for small practices has roughly halved, ordinary sponsor-to-sponsor sales have become scarce, and buyers have used their stronger position to change the shape of the price rather than only its size. A headline offer of $10 million might arrive as $6 million cash at closing, $3 million in rollover equity, $500,000 held in escrow for a year or two, and $500,000 paid only if the practice hits a revenue target.
A few words are worth defining. A seller note is a promise by the buyer to pay you a fixed amount on a schedule, usually with interest. A holdback (or escrow) is part of the price set aside for a year or two in case problems turn up, and paid to you if they do not. An earnout is additional price paid only if the practice hits agreed targets after closing. All three are installment obligations for tax purposes. The rollover equity page covers the equity; this page covers the rest.
When at least one payment for a sale arrives after the year of sale, Section 453 lets you report the gain as the money comes in rather than all at once. This is the default, and you do not have to elect it.
The mechanics turn on the gross profit ratio: your total gain on the sale divided by the total contract price. Each payment you receive is multiplied by the ratio to find the gain you report that year; the rest is a tax-free return of your basis. For most physicians who built their practice rather than bought it, basis is close to zero, so the ratio is close to 100 percent and nearly every dollar received is gain.
The character of the gain does not change because it arrives later. Payments for goodwill are capital gain whenever they arrive. Payments allocated to a covenant not to compete are ordinary income whenever they arrive. The installment method spreads the timing; it does not improve the rate. The tax pillar page explains how the purchase price allocation sets that character.
Suppose you sell your share of a practice for $8 million with a basis of zero. You receive $6 million at closing and a $2 million seller note payable in two equal installments over the next two years. Your gross profit ratio is 100 percent. You report $6 million of gain in the year of sale, $1 million the next year, and $1 million the year after. The tax on each later payment is due for the year you receive it, so reserve for it out of the payment.
An earnout does not have a fixed price, so the gross profit ratio cannot be computed the normal way. Temp. Reg. 15A.453-1(c) provides three rules, applied in order.
Some sellers hope to treat an uncertain earnout as an open transaction under the old Supreme Court case Burnet v. Logan, recovering all of their basis before reporting any gain. The regulations allow this only in rare cases. For a practice sale with a low basis, the distinction matters less than it sounds, because there is little basis to recover under any rule.
When a buyer pays you later, the tax law assumes part of the payment is interest for the wait, whether or not the contract says so. Sections 483 and 1274 require a deferred payment to carry at least a minimum rate of interest tied to the applicable federal rate. If your seller note or earnout states no interest, or too little, the IRS recharacterizes part of each payment as interest. That interest is ordinary income at up to 37 percent federal rather than capital gain at 20 percent, and the principal portion of the payment shrinks by the same amount. A seller note that states a market rate of interest gives you the same ordinary income but with the cash to match. An earnout with no stated interest gives you ordinary income carved out of a payment you thought was all capital gain.
If the earnout is payable only while you remain employed by the platform, the IRS can recharacterize it as compensation for your services rather than additional price for your practice. Compensation is ordinary income at up to 37 percent, it is subject to payroll tax (Social Security and Medicare taxes, plus the 0.9 percent additional Medicare tax at your income), and the buyer deducts it right away, which is why buyers sometimes prefer that framing.
The fix is in the drafting. An earnout tied to the practice's revenue or EBITDA, payable to all selling owners in proportion to their ownership regardless of who is still working, and surviving your death or disability, looks like purchase price. An earnout tied to your personal production, forfeited if you resign, and paid only to the physicians who stay looks like a retention bonus. If you accept the second version, budget for the tax as compensation and negotiate a larger gross amount to make up the difference. The second bite page covers the related problem of rollover equity tied to continued employment.
Depreciation recapture is recognized in the year of sale no matter when you are paid. Section 453(i) says so directly. If your practice expensed lasers, scopes, imaging equipment, or dental chairs under bonus depreciation or Section 179, the gain on that equipment up to the amount you deducted is ordinary income under Section 1245, and all of it is reported in the year of sale even if 40 percent of the price is a note or an earnout. The practical problem is cash. A practice with $1.5 million of fully depreciated equipment that takes most of its price in deferred form can owe tax on $1.5 million of ordinary income at closing with a check that does not cover it comfortably after fees and the rollover. Ask your CPA to compute the recapture before you agree to the mix of cash and deferred consideration.
Yes. Section 453(d) lets you elect out on your return for the year of sale, in which case you report the fair market value of the note or earnout right in that year and pay tax now. Reasons to consider it include a year of sale with unusually large deductions or losses to absorb the gain, a belief that rates will be higher later, or a wish to avoid the Section 453A interest charge described next. Reasons not to include paying tax on an earnout you may never receive, and the fact that the election is difficult to revoke. Run the numbers both ways before the return is filed; the choice cannot be made later.
Section 453A charges you interest for the privilege of deferring tax on a large installment sale. A seller who holds a $10 million note and pays tax as the payments arrive has, in effect, borrowed the deferred tax from the government, and the charge is the interest on that loan.
It applies when two things are true at the end of your tax year: the sale price was more than $150,000, and the total face amount of your installment obligations from such sales still outstanding exceeds $5,000,000. Physicians selling a single share of a practice for under $5 million are below the line. Partners in a large group with a big seller note or a large fixed earnout can be above it.
The formula has three parts, multiplied together.
The result is added to your income tax for the year. It is not deductible by an individual. It recurs every year that the obligations outstanding at year end remain above $5 million.
Assume a physician sells her share of a large group for $15 million with zero basis, all of it allocated to goodwill. She receives $8 million at closing and a $7 million seller note, none of which has been paid by December 31. Assume, for illustration only, an underpayment rate of 8 percent; the real rate is set by the IRS each quarter and is not this number. Her unrecognized gain on the note is $7 million, and the deferred tax at 20 percent is $1.4 million. The obligations above $5 million are $2 million out of $7 million, so the applicable percentage is 2 divided by 7, or about 28.6 percent. The interest charge is $1.4 million times 28.6 percent times 8 percent, or about $32,000 for the year, added to her tax bill and not deductible. If the note is still fully outstanding the following December, the charge repeats. Nothing about this changes the tax on the gain itself; it is a cost on top.
| Step | Amount |
|---|---|
| Face of installment obligations outstanding at year end | $7,000,000 |
| Unrecognized gain on those obligations (zero basis) | $7,000,000 |
| Deferred tax liability at 20 percent | $1,400,000 |
| Obligations above the $5,000,000 threshold | $2,000,000 |
| Applicable percentage ($2,000,000 divided by $7,000,000) | 28.6% |
| Assumed underpayment rate (illustration only) | 8.0% |
| Section 453A interest for the year ($1,400,000 x 28.6% x 8.0%) | about $32,000 |
Two design choices reduce or remove the charge. Keeping the outstanding balance at or under $5 million at each December 31, by taking more cash at closing or scheduling a principal payment before year end, avoids it entirely. Electing out under Section 453(d) also avoids it, at the price of paying all the tax now. Neither is automatically right; a seller who can earn more on the deferred tax than the underpayment rate may prefer to pay the charge.
A seller note or earnout is a loan you have made to the buyer, and you should think about it the way a bank would. Your note is almost always unsecured and sits behind the platform's lenders. Private equity-backed medical groups carry substantial debt, and some have failed. Envision Healthcare, backed by KKR, filed for Chapter 11 in May 2023 and emerged that November owned by its lenders with its debt cut by roughly 70 percent. Prospect Medical Holdings, backed by Leonard Green, filed for Chapter 11 in January 2025 with more than 11,000 affiliated physicians. A Bloomberg Law analysis in July 2026 found that clinics and physician practices were about 30 percent of healthcare Chapter 11 filings with $10 million or more of liabilities in the first half of 2026.
In a bankruptcy, unsecured seller notes and earnout rights are often paid a fraction of face or nothing, and you may already have paid tax on the recapture and on the payments you did receive. Before accepting a large deferred piece, ask for the platform's debt terms and leverage, ask whether the note can be secured or guaranteed by the parent, and price the deferred dollars as worth less than cash. The second bite page covers the same credit question for your rollover equity.
For installment payments, often yes. California's sourcing rule, 18 CCR 17952, states that if a California resident sells intangible property on the installment method and later becomes a nonresident, any gain from later installment payments on that sale is sourced to California. Goodwill is intangible property. A physician who sells in California, moves to Texas the following year, and then collects a $3 million seller note owes California tax at up to 13.3 percent on the gain in those payments, even while living in a state with no income tax. Moving before the sale is a different question, covered on the California page. New York reaches a similar result: installment payments from a New York-source sale keep their New York-source character after you move. If you are planning a move, the deferred portion of the price is the portion that will follow you.
If your deferred consideration is small, say a one-year holdback of 5 to 10 percent of a price under $5 million, the installment method will take care of itself and Section 453A is not in play. Your effort belongs on the allocation and the employment agreement instead. If all of your deferred value is rollover equity rather than a note or earnout, the rules on this page do not apply; the rollover is governed by Sections 721 and 351 and is covered on the rollover equity page. And if your earnout is openly structured as a retention bonus, with the buyer treating it as wages, there is no installment sale to plan around.
Before you agree to the mix of cash, note, holdback, and earnout, ask your CPA for four numbers: the depreciation recapture you will owe in year one regardless of when you are paid, the face amount of installment obligations you would hold at December 31 of the closing year, the Section 453A charge if that amount exceeds $5 million at the current underpayment rate, and the state tax that will follow the deferred payments if you plan to move. Then read the earnout language with your deal counsel for any condition tied to your continued employment, and ask that it be tied to practice performance instead. Finally, ask the buyer for its lender documents and leverage, because the value of every deferred dollar depends on whether the buyer is still solvent when it comes due.