When you buy a business, you should make sure that the seller is caught up on paying state taxes. If you don’t, you might find yourself stuck with the bill after closing. Worse yet, you might find that your shiny new business is encumbered by a tax lien.
In every state I’m aware of, the law allows state taxing authorities to assess the buyer of a business for unpaid taxes of the seller — even if the transaction is structured as an asset sale. Tax obligations follow the business assets, even if the purchase agreement says that the buyer isn’t taking on those liabilities.
Protection against unpaid taxes
There are a number of ways buyers can protect themselves. First, as always, buyers can perform due diligence, such as reviewing tax returns and comparing the amount of taxes paid with the expected tax liability based on financial performance as recorded in the financial statements.
Second, the purchase agreement should state that the seller retains responsibility for pre-closing tax liabilities. It should also contain a representation by the seller that all taxes have been paid, and it should contain an indemnification obligation that requires the seller to foot the bill for any taxes that the buyer is assessed post-closing. These protections are standard and won’t be controversial for most deals.
If there’s seller financing, the buyer can negotiate a set-off right to permit the buyer to withhold amounts paid after closing for the seller’s tax obligations from future payments owed to the seller under the seller note. As another protection the buyer can pay a portion of the purchase price into an escrow account to be held until the buyer’s risk of being assessed for the seller’s taxes has abated. These two protections are less standard, but still perfectly reasonable requests in most cases.
What is tax clearance?
But the best protection is to obtain a tax clearance certificate. A tax clearance certificate is a document issued by a state taxing authority that confirms that a company is current on its tax obligations. Some states refer to the process as a “bulk sale” (not to be confused with bulk sale laws under Article 6 of the Uniform Commercial Code that protect trade creditors, which have been repealed in many states). Some states don’t have a tax clearance process, but if a tax clearance process is available, it’s usually advisable to comply.
First, a couple of downsides: In some states a tax clearance request can trigger an audit of the seller by the taxing authorities. Also, the tax clearance process usually takes a week or longer, so waiting for a certificate could slow down the deal. I’ve seen certificates delayed beyond the normal processing time for minor administrative reasons even when the company didn’t owe any taxes. Not the sort of delay you want to see on the final stretch to closing. Finally, states often require money to be paid into escrow or withheld by the buyer, which delays payment to the seller. For these reasons, it’s not unusual for buyers and sellers to forego the tax clearance procedure.
How tax clearance works
The tax clearance process varies from state to state. But to illustrate, I’ll describe the process in Missouri, which is where many of my deals take place. First, a bit about the law. Here’s a short summary:
Under RSMo § 144.150 (for sales and use taxes) and § 143.241 (for withholding taxes) sellers are required to file a final tax return within 15 days after the sale of their business. They are also required to provide the buyer before closing with a statement from the director of revenue of the amount of taxes that the seller owes or a certificate stating that no taxes are due. If the seller fails to do this, the seller will be assessed a penalty in the amount of 25% of the tax delinquency. This penalty can’t be passed on to the buyer.
Upon request by the seller, the director of revenue is required to provide, within 15 business days of receiving the request, a statement of the amount of taxes that are due or a certificate stating that no taxes are due.
The buyer is required to withhold from the purchase price enough money to cover the seller’s unpaid taxes. If the buyer doesn’t withhold the funds, the buyer is liable for the seller’s unpaid taxes. Like I said, the seller’s unpaid taxes are the buyer’s problem no matter how the transaction is structured.
The request for a statement of the amount of taxes due or a certificate that no taxes are due is made by filing a Form 943, Request for Tax Clearance, with the Department of Revenue. The simple one-page form can be mailed or faxed. Here’s a screenshot of the form:
- Through the tax clearance process, buyers of businesses can protect themselves from the seller’s unpaid state sales, use, and income taxes.
- The seller must submit a Form 943, Request for Tax Clearance before closing.
- The director of revenue is required to provide, within 15 business days, a statement of the amount of taxes due or a certificate that no taxes are due.
- If taxes are owed, the buyer must withhold the appropriate amount from the purchase price.
- If the buyer doesn’t follow the tax clearance process, the buyer will be assessed with the seller’s unpaid taxes.
- If the seller doesn’t follow the tax clearance process, the seller will owe an additional penalty of 25% of the tax arrearage.
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