Buying a business with tax liability: What you need to know

When you buy a house, you hire an inspector to check out the roof, foundation, electrical systems, and other parts of the property. If they find any problems, you have a few courses of action: the seller can fix the issues at their own expense, or the buyer can take on the responsibility, the seller can lower the purchase price to reflect the cost of the repairs, or the buyer can back out of the sale altogether. It’s easy to understand why an inspection is an absolute requirement when buying a home; you want as much information as you can get before you make a huge investment.

Buying a business is similar; it’s a huge investment with a lot of potential risk, especially with respect to tax liability. So what happens with sales tax liability when you buy a business? We answer that question and more.

What is due diligence and how does it affect business acquisitions?

Who is responsible for sales tax when a business is sold?

What counts as tax liability when buying a business?

What should my company do before buying or selling a business?

What if I owe money?

Just like a home inspection can help determine problems in a house before the sale, due diligence can help uncover liabilities in a business before any type of business merger or acquisition (M&A). Due diligence is an investigation into the selling company’s documents, data, and other information — including sales tax liability. The buyer reviews the results and identifies any risks or liabilities in the potential purchase.

When the potential buyer reviews the information and potential liabilities, they can make a few different decisions. If the selling business has bad investments or other problems, the buyer can back out of the sale altogether, or work with the buyer to either reduce the purchase price or make the sale contingent on the selling business making good on the money they owe.

One of the things due diligence can uncover is unpaid sales tax liabilities. If a business hasn’t been remitting sales tax to the appropriate jurisdictions as required, it can result in back taxes, penalties, and interest being owed. And if they weren’t sales tax compliant for a long time, it can result in a huge bill for the purchaser. 

At a high level, business acquisitions can be structured as a stock purchase in which the buyer purchases the entire company, including all the assets and liabilities of the company, or as an asset purchase through which the buyer only purchases the assets of a business, such as equipment, inventory, or real estate. From a sales tax perspective both transaction types have the potential for the buyer to be stuck with pre-acquisition sales tax liabilities incurred but not paid by the seller, though asset transactions generally pose less risk for the buyer.

When a company purchases the stock of another company, the purchasing company is acquiring both the assets and the liabilities of the selling company. So they’re also on the hook for any sales tax owed. If your business buys a business and later discovers that business hadn’t been paying the correct (or any) sales tax in a few different states, your company has a lot of work to do to make things right.

Although buyers typically take on fewer liabilities in an asset purchase, governments may still be legally entitled to collect unpaid sales tax from asset buyers through successor liability or similar statutes. The impact of sales tax liabilities can be very different depending on the type of purchase, so it’s important that you know which ones apply to your business.

Tax liability is the amount of tax debt a company or individual owes to the government. This includes income taxes, employment taxes, excise taxes, property taxes, and sales taxes. In an ideal situation, a business would be collecting and remitting all necessary taxes and paying them on time, reducing the chance of becoming noncompliant.

Unfortunately, even the most conscientious businesses can make mistakes or overlook aspects of tax compliance. When acquiring a business, it’s a good idea to pay close attention to nexus, exemption certificates, and property tax.

Sales tax nexus

Nexus is a common cause for getting tripped up when it comes to sales tax. Nexus is a connection between a business and a state or other taxing jurisdiction that triggers a sales tax obligation for the business. It can be established in a number of different ways, including having a physical presence in a state or meeting a certain threshold of sales and/or transactions in another state (economic nexus). 

Every state that has sales tax has economic nexus laws on the books, but economic nexus thresholds differ. It’s important to note that if the selling company has nexus in a state where the buying company does not, a business sale will establish nexus for the buying company.

One way to figure out where you have sales tax obligations is by taking a nexus assessment. Once you find out where you owe sales tax, the next step is to register to collect and remit tax wherever you owe.

Exemption certificates

Another common compliance issue is sales tax exemption certificate management. If your business makes tax-exempt sales or has tax-exempt sellers, you must collect, verify, and store the documents for those sales to prove the sales were exempt.

If your company purchases a company that makes exempt sales or purchases, you’ll need to ensure all certificates are updated and contain the correct information. 

Property tax

Property tax can get tricky in an M&A situation. All of a sudden the purchasing company may acquire a wealth of new property — both in real estate and in personal property, like machinery or office furniture. 

Other taxes and fees

The purchasing company should also take note of any indirect taxes, like retail delivery fees, the selling company is responsible for. These can include business and occupation (B&O) tax, franchise tax, excise tax, bag fees, environmental fees, and others. 

Incorrect sales tax classifications

A purchasing company is also responsible for the tax mistakes the selling company may have been making. A common issue is incorrect sales tax classifications; treating an item as exempt when it should have been taxable, or vice versa. 

If your company is the one making the purchase, you should conduct a due diligence investigation and get a full picture of the selling company’s tax compliance situation. The goal is to identify unpaid tax liabilities before the purchase to avoid overpaying for a business and to avoid unexpected liabilities.

If your company is the one selling, you should review all aspects of your business’s tax compliance to ensure there are no significant unpaid taxes. Unpaid sales tax liabilities have the potential to derail a sale transaction.  

Whether your company is the one selling or the purchaser, if you find you have more tax liability than you thought, you can file a voluntary disclosure agreement (VDA). A VDA is a contract between a company and the state or other taxing jurisdiction that allows the company to reduce the amount of tax owed. If you owe a large amount of back taxes or fees, a VDA might be a good option for your business. If the state has to come to you for taxes owed, the penalties could be much more severe. 

The best way to prepare for a business sale is to manage sales tax, exemption certificates, and other compliance tasks early. Automation can help; Avalara AvaTax helps companies like yours calculate sales and use tax across industries, borders, and tax types, making sure your business stays compliant no matter how it grows or changes. 

For other aspects of tax management, Avalara Property Tax and Avalara Exemption Certificate Management can help you get — or stay — tax compliant, giving you less to worry about when it comes to M&A activities and ensuring smooth sale-ing.