Seller Note Interest Rate: The Applicable Federal Rate Minimum, Imputed Interest and What to Charge on a Business Sale

Short answer: the floor is the applicable federal rate for the term of the note, published monthly by the IRS. For September 2026, Rev. Rul. 2026-17 sets the annual AFR at 4.18% short-term, 4.49% mid-term and 5.12% long-term. Charge less than the rate that applies to your note and sections 483 and 1274 recharacterize part of the principal as interest, which moves money out of the capital gain column and into ordinary income. What buyers and sellers actually agree in a small US business sale usually sits well above the floor, because the AFR is a tax test rather than a market price. Last updated September 2026. Educational only, not tax or legal advice.

This is one of the few numbers in a small acquisition that has a genuinely correct answer, and it is also one of the most commonly guessed. A seller carrying paper for a buyer they like picks a round number, or picks zero as a courtesy, and finds out at filing time that the IRS has an opinion about it. The rules are short and they are worth reading once.

What is the minimum interest rate the IRS allows on a seller note?

The applicable federal rate for the term of the instrument. IRS Publication 537 sets out the ladder without ambiguity: for a term of three years or less the AFR is the federal short-term rate, for a term of over three years but not over nine years it is the federal mid-term rate, and for a term of over nine years it is the federal long-term rate. Those are the only three buckets. A five year seller note, which is the most common shape on a small US business sale, sits in the mid-term bucket.

Those are the annual compounding figures from Rev. Rul. 2026-17, read directly from the IRS release on 6 September 2026. The same ruling publishes lower figures for more frequent compounding, because compounding more often gets you to the same effective yield with a smaller stated rate: short-term runs 4.14% semiannual, 4.12% quarterly and 4.10% monthly; mid-term runs 4.44%, 4.42% and 4.40%; long-term runs 5.06%, 5.03% and 5.01%. If your note pays monthly, which most seller notes do, the monthly column is the one to compare against.

Two cautions about these numbers. First, they change every month, so a rate that clears the test in September may not clear it in December. Second, several widely shared summaries of this topic mix up the months and the terms, and at least one currently in circulation reports the September long-term figure as a March mid-term figure. Pull the revenue ruling for the month your contract becomes binding rather than trusting a table someone typed up.

Which month's AFR applies to my note?

Not necessarily the month you close. Publication 537 defines the test rate of interest for a contract as the lower of the applicable federal rates for the three month period ending with the first month in which there is a binding written contract. That is a small mercy in a rising rate environment and a small trap in a falling one, and it means the date the parties actually became bound matters more than the date the money moved. If a letter of intent hardened into a binding agreement in July and closing slipped to September, the July date is likely to be the one that starts the clock. That is a question for your own adviser, because whether a given document is binding is a legal question rather than an arithmetic one.

What happens if the seller note charges no interest?

The interest gets invented for you. Publication 537 explains that if an installment sale contract does not provide for adequate stated interest, part of the stated principal amount of the contract may be recharacterized as interest, and it names the two regimes that do it: if section 483 applies the amount is called unstated interest, and if section 1274 applies it is called original issue discount. Either way the effect on the seller is the same in direction. Principal that would have been capital gain, spread across the term at the gross profit percentage, becomes ordinary income instead.

That is why a zero interest note is an expensive way to be generous. A seller who wants to give the buyer a break is better off reducing the purchase price and charging a proper rate, because the price reduction is a real concession that lands as a smaller capital gain, while the below-market rate is a paper concession that the code reverses and taxes at a higher rate. The buyer is no better off either: the imputed interest they are treated as paying is deductible, but the smaller principal is not, so the structure that looked like a favour mostly just reallocates the same money to a worse tax outcome for one side.

What interest rate do seller notes actually carry?

Considerably more than the AFR, because the AFR is a floor for tax purposes and not a price for credit. A seller note is unsecured or second-lien lending to a first-time owner of a business the seller no longer controls, and it should be priced like that. The useful reference point is the bank prime loan rate, which the Federal Reserve H.15 release put at 6.75% on 4 September 2026. A seller taking materially more risk than a secured bank lender and charging materially less than prime is subsidising the buyer, whatever the note says on its face.

There is a second reason the market rate runs high, and it is structural rather than a matter of taste. On a deal financed with an SBA 7(a) loan, the seller note is often subordinated to the bank. SBA SOP 50 10 8, effective 1 June 2025, requires a minimum 10% equity injection on a change of ownership and allows a seller note to count toward that injection only if the note is on full standby for the entire term of the loan and does not exceed 50% of the injection. Full standby means no principal and no interest paid to the seller while the SBA loan is outstanding. On a ten year acquisition loan that is a decade of accrual with nothing arriving, which is a very different instrument from a five year amortizing note, and pricing the two the same is a mistake. If you are working through that structure, the mechanics on an SBA loan to buy a business set out what the equity injection rules do to a deal before the rate conversation starts.

How is seller note interest taxed?

Separately from the gain, and less favourably. Principal payments carry gain that is taxed at the gross profit percentage as each payment arrives, which is the installment method working as intended. Interest is not part of that calculation at all. It is reported as ordinary interest income in the year received, at the seller's ordinary rate, and it is excluded from Form 6252 entirely. That split is the whole reason the adequate stated interest rules exist: without them, sellers and buyers would agree a high price with no interest and convert ordinary income into capital gain by contract.

The rest of the reporting mechanics, including the gross profit percentage, the year-one recapture rule and the section 453A thresholds, sit with the deal rather than with the note. If you are structuring one, the full picture is on installment sale of a business and Form 6252, and the way a note interacts with an earnout or a holdback is covered under earnouts, seller notes and working capital adjustments.

Does the AFR apply to an earnout as well as a note?

Often yes, and it surprises people. A contingent payment obligation that stretches past the year of sale can carry unstated interest in the same way a fixed note does, because the code is looking at deferred payment rather than at the label on the document. The practical consequence is that a slice of an earnout payment received in year three may be treated as interest rather than as purchase price. Anyone pricing an earnout at face value is overstating what it is worth after tax.

What to do before you sign

Four things, in order. Pull the revenue ruling for the month the contract becomes binding rather than the month you close, and take the rate for the actual term of the note. Compare it against prime and against what a bank would charge for the same risk, then price the note on the credit rather than on the tax floor. Get the allocation of the purchase price agreed in the document rather than after it, because the purchase price allocation and Form 8594 decide which slices of the deal are installment eligible at all. And put the note itself in a real document with a real signature: a promissory note is the instrument that makes the whole structure enforceable, it costs a few hundred dollars to have drafted, and getting both parties to sign and return the executed copy the same week is worth more than any rate you negotiate.

The seller note is usually the last term agreed and the first one regretted. Sellers who treat it as a rounding detail at the end of a long negotiation are the ones still chasing payments three years later. Sellers who treat it as what it is, an unsecured loan to a stranger with a new job, tend to end up with a shorter term, a bigger down payment and a rate that reflects the risk. The IRS minimum is the beginning of that conversation, not the end of it.

Sources read firsthand on 6 September 2026: IRS Rev. Rul. 2026-17 for the September 2026 applicable federal rates; IRS Publication 537 for the test rate ladder and the unstated interest rules; 26 USC 453 and 26 USC 453A; and the Federal Reserve H.15 release dated 4 September 2026 for the bank prime loan rate. SBA figures are from SOP 50 10 8, effective 1 June 2025. Nothing here is tax or legal advice.