What Happens If You Buy a Business That Owes Taxes?
If you're buying a business, you must structure the deal carefully to ensure you aren't responsible for unpaid taxes. Sellers also need to ensure that they complete all of the necessary paperwork so they don't incur any liability for the new owners' tax debts.
You should work with a local tax attorney during the acquisition process. They can help you ensure your interests are protected. Are you dealing with a tax bill after buying a business? Contact a local tax professional for help today.
In the meantime, here is an overview of the essentials to help you out.
Buying Unincorporated Vs. Incorporated Businesses
Generally, when you buy an unincorporated business, you don't assume any of its tax debts. If you buy a corporation, you only assume its tax debts if you buy its stocks. You don't assume the corporation's debts if you only buy its assets.
Unincorporated businesses include pass-through entities such as sole proprietorships, partnerships, and unincorporated LLCs. When these businesses file tax returns, the tax liability becomes the owner's personal responsibility. If the owner(s) sells the business, they remain responsible for its tax liabilities. This includes IRS payroll and income taxes, but it typically also includes state payroll and sales taxes. However, the rules vary from state to state.
In contrast, buying a corporation's shares makes you responsible for all of the business's liabilities. This includes delinquent taxes but can also include new taxes assessed during an audit.
Delinquent Taxes and Taxes Assessed in an Audit
As noted above, when you purchase a corporation's shares, you also purchase its debts. This includes bank notes, equipment-secured loans, tax debts, and other business liabilities. For instance, if the business owes $20,000 in payroll tax, you assume that debt when you buy the business.
However, you don't just need to worry about unpaid taxes. You also need to be aware of taxes that haven't been assessed yet. To give you an example, imagine that you buy a corporation's shares. A year later, the IRS audits its corporate income tax returns. The audit reveals that the company overstated its deductions and it owes tax. As the current owner, you are responsible for that tax liability even though you didn't own the business when the return was filed.
How to Protect Yourself From Tax Debts When Buying a Business
Do not overlook tax debts during the due diligence process. Unpaid taxes increase the liabilities you assume when buying a business. They also affect the valuation of the business, and if you fail to take them into account during negotiations, you may end up paying more than you should for the business. Keep the following tips in mind:
Request proof that the business is current on tax payments.
To protect yourself, request proof that the business is current on its tax filing and payment obligations. For instance, you may want a copy of the business's tax transcript from the IRS and a certified letter from your state revenue agency.
Every state has different processes. California, for example, issues a CDTFA–471 (Certificate of Payment) to show that a business is current on its obligations. In contrast, in Colorado, you can file Form DR0096 to request a tax status letter about a business you are purchasing.
Audit the company's tax returns.
You may also want to audit the company's tax returns. This helps to protect you from an unexpected tax liability related to an audit. It also gives you some reassurance that the company's financial records are accurate.
You may want to review corporate income tax returns, federal payroll tax returns, state sales tax returns, state withholding returns, and any other returns filed by the business.
Check for tax liens.
Make sure there are no tax liens against the business's assets. Again, tax debts generally don't transfer when you buy an unincorporated business. However, a tax lien attached to an asset will transfer.
Checking for liens should be a standard part of the due diligence process when you buy a business, but this step often gets overlooked with private transfers. Make sure that all of the assets you're buying have unencumbered titles with no liens from tax agencies or private creditors.
State Laws on Tax Debts During Business Acquisitions
State laws vary on how tax liabilities transfer when you purchase a business. For example, if you buy a business in Colorado, you must withhold the seller's tax debts from the purchase price unless you have a tax status letter. Failure to do so can make you liable for the taxes.
In California, buyers can be liable for the seller's unpaid taxes if they don't receive a Certificate of Payment from the CDTFA. You can end up being liable for taxes owed from $500 to the purchase price of the business. On the flip side, if the seller doesn't notify the state about the sale, they may end up being liable for taxes incurred by the buyer.
In some cases, the CDTFA can hold both the seller (predecessor) and the buyer (successor) responsible for the same tax liability. The variety of state regulations makes it critical to work with a tax professional who is experienced with the laws in your state.
Unassessed Payroll Taxes
In some cases, you may end up dealing with unassessed payroll taxes. Typically, this comes into play when the business wasn't aware that it had a state filing obligation. For instance, a business located in one state may incur a payroll tax liability if its employee works temporarily in another state.
Every state has different rules about when nonresidents' employers must withhold payroll taxes but in all states, the statute of limitations doesn't start running until after the return has been filed. As a result, a buyer may be exposed to unassessed payroll taxes that go back to the business's formation. However, note that this typically only applies if you purchase a corporation.
Unassessed Sales Tax
Buyers can also face similar situations with unassessed sales tax. This has gotten increasingly complicated after the Wayfair Vs. South Dakota case. That ruling changed how nexus is determined for state sales tax, and it exposed a lot of online retailers to sales tax in many different states where they didn't previously have to pay or file returns.
Again, the statute of limitations for audits and collections doesn't start until the tax has been assessed. If a business hasn't been filing sales tax returns as required, the state may assess sales tax against it at any time. This means that the buyer may be exposed to old tax liabilities that go back for years.
Updating the Responsible Party
As indicated above, there can be situations where the seller is responsible for the buyers' unpaid taxes. The Employer Identification Number (EIN) typically doesn't transfer when you buy a business. The new owner will need to obtain a new number.
However, in cases where the business will continue to use the same EIN, the seller should make sure that they are no longer the responsible party. File Form 8822-B (Change of Address or Responsible Person) and update the name of the responsible party.
In the past, the IRS had held sellers responsible for the buyers' unpaid payroll tax when the seller failed to file this form. This tax liability can come up years after you've sold your business. When the seller appealed, the Tax Courts upheld the IRS's decision.
Get Help With Business Tax Debts Today
Buying a new business is an exciting opportunity, but it can be marred if you also end up incurring tax debts. To get help, reach out to a local tax pro today. Using TaxCure, you can search for local tax professionals in your area, and you can narrow down your search based on their experience with certain tax agencies or tax problems.