What Happens If I Purchase a Business with a Tax Liability?

Not so long ago, if a business owner decided to put his company up for sale, all the tax liabilities associated with said business had to be paid first.

Now, it’s buyer beware. In order to further the chance of securing tax liabilities, the government has widened its focus in order to get its tax debts paid and money in the treasury. 

This widening now encompasses the purchasers of the business. If the buyers are not careful, they can find themselves having to shell out more money to cover the previous owner’s unpaid tax debts during the escrow process.

A buyer should always require the seller to provide certified letters from tax agencies showing all tax debts have been settled. Individuals who wish to buy or sell a business need to pay extra attention to the circumstances surrounding the transaction. Buyers and sellers can be responsible for any tax liabilities that were incurred prior to the sale.

This can cause additional burden to the purchaser if the seller had defaulted on their tax responsibilities, which transfers the debt to the new owner. Trying to collect back taxes from the seller is often fruitless, which socks the purchaser with dual taxation.

Successor Liability 

The purchaser of a business of stock of goods is a successor and should request from the seller (predecessor), a Certificate of Payment (CDTFA-471). In most cases, this protects the purchaser from liabilities incurred by the selling company. 

However, in some instances, the successor will be responsible for existing and future liabilities associated with the previous owner.

Some examples are if the purchaser agreed to assume the predecessor’s liabilities or if the liabilities were fraudulently transferred to the successor in order for the seller to avoid payment.

The CDTFA will first attempt to collect from the predecessor. If that is unsuccessful, the successor will receive a notice of successor liability and collection proceedings will begin. A notice of successor liability is issued for any amount owed by the predecessor over $500, up to the purchase price of the business or stock of goods.

A successor's liability only extends to the amount the successor was required to withhold from the purchase price at the time the successor purchased the predecessor's business or stock of goods.

The liability incurred by a successor with regard to the purchase of a business or stock of goods includes all amounts incurred by the predecessor (or any former owner), from the operation of the business, including amounts incurred from the sale of the business, even though such amounts may not be determined as of the date of purchase. 

All tax, interest, and penalties incurred by the predecessor, up to the amount of the purchase price, shall be billed to the successor.

Although the successor liability billings are not directly subject to accrual of interest, successors are liable for all the predecessor's tax, penalty, and interest, including interest accrued after the issuance of the notice of successor liability.

Duel Determinations Against Predecessor

When a predecessor (seller) fails to notify the CDTFA that they discontinued, sold, or transferred their business, the predecessor may be held liable for tax, interest, and penalty (except for fraud or intent to evade) incurred by the successor/transferee. 

However, the limitation on liability does not apply in cases where, after the transfer, 80  percent or more of the real or ultimate ownership of the business is still owned or held by the predecessor (see RTC section 6071.l (a) and (b), and Regulation 1699.)

Collection problems can arise due to the lapse of time between the determination of liability against the successor and issuing a dual determination against the predecessor. Some examples of these problems are:

1. The predecessor's account is closed out with no record of a liability and the predecessor's security deposit is refunded prior to issuing a dual determination.
2. The predecessor is not immediately informed of a tax liability that he/she shares equally with the successor.
3. The predecessor's file, along with possible collection leads, may have been destroyed prior to issuing the dual determination.

When a predecessor's liability is involved, three determinations may result.

1. A determination issued against the predecessor for any period that he/she actually operated the business.
2. A second determination issued against the successor for the period during which he/ she operated the business.
3. A dual determination issued against the predecessor concurrent  with the  issuance of a determination against the successor.

In the case of a billing for predecessor's liability, current practices applying to dual determinations will be followed. The only exception would arise if a 25 percent fraud penalty is applied to the successor's tax liability.

Sales and Use Tax Regulation 1699(e) specifically states that the predecessor is not liable for any fraud penalties. In this instance, the fraud penalty will be replaced by a 10 percent negligence penalty on the dual determination issued against the predecessor.