Do you inherit sales tax when buying a business?

• Successor liability means that you can inherit sales tax obligations when buying a business.

• Due diligence is a process before the sale that surfaces information about a company’s tax exposure, status, and history.

• Looking at tax considerations when buying a business gives you the most control over an acquisition so you can negotiate sales terms and prepare cash flow strategies.

Acquiring a new asset is exciting. But sales tax compliance in mergers and acquisitions can make the path forward more complicated than you might think.

Protect yourself by understanding successor liability, how to reduce sales tax risks through due diligence and contract terms, and the tools that can help you pay for inherited tax obligations.

Successor liability means that a buyer acquiring a business can face exposure for certain taxes owed by the seller.

An equity purchase of a business is more likely to result in successor liability for any unpaid taxes. But sales tax on an asset purchase can still put the buyer on the hook in some cases if they do not carefully assess and mitigate risks.

Whether or not successor liability applies to a specific acquisition depends on the relevant state or tax jurisdiction and the details of the sale. It also depends on the tax status of the seller’s business. Unpaid sales taxes can create successor liability exposure.

Before you buy a business, you should plan for the tax implications — including the risks associated with unpaid sales and use tax. This process is called due diligence.

A sales tax due diligence process can reveal the underlying tax status and risk profile of the potential acquisition, and the information uncovered allows you to mitigate risks and move forward (or not) with a plan that aligns with your business goals, assets, and risk tolerance.

Sales tax compliance in mergers and acquisitions can be especially complicated without the help of a professional. Always consult your tax advisor for up-to-date information.

Evaluate the seller’s tax exposure

The first step of sales tax due diligence is to look at the realities of a business’s tax exposure. You should review where the business has operated, registered, collected sales tax, and filed returns. This can help you estimate potential liability and identify exposure periods.

Relevant documentation may include accounts payable, tax returns, audit findings, unresolved assessments, and exemption certificates.

If any jurisdictions have unresolved assessments, a history of requested audits, or incomplete exemption certificates, those issues warrant closer review.

Review the bulk-sale notice and tax clearance certificate

Continue assessing the history and risk profile of a potential acquisition by reviewing additional documentation, such as the bulk-sales notice and tax clearance certificate. The responsible party and filing deadlines for this kind of paperwork vary by state, but here are the basic requirements.

A bulk-sale notice notifies the state of a sale before the transaction closes so that outstanding taxes can be addressed. This is required by many states when a business sells a substantial portion of its assets. If the seller does not want to file a bulk-sale notice, this can be a red flag for tax exposures. However, the notice itself does not reveal specific details about tax or debts.

A tax clearance certificate is documentation from the state (or another relevant tax jurisdiction) certifying that specified tax obligations have been satisfied. This may be required in some states for certain business sales. Even if it’s not required, a tax clearance certificate can provide clarity and official documentation on the tax obligations associated with a potential acquisition.

Both of these should be completed well ahead of closing the sale. If the seller is transparent and cooperative throughout the bulk-sale notice process and you obtain a valid tax clearance certificate, these can be good signs that you won’t inherit undocumented sales tax liabilities in the sale.

You should still be wary of unregistered activity and protect yourself with clear purchase terms.

Address sales tax exposure in the purchase agreement

In the case where a business has outstanding tax exposure or obligations, you can protect yourself from successor liability by structuring your purchase agreement appropriately.

The purchase agreement can clearly outline and allocate responsibility for pre-closing sales tax liability (though it cannot supersede state requirements). Contracts can include provisions such as:

• Tax release confirmation from a tax authority that it will not pursue certain tax liabilities against the buyer for transferred assets

• Indemnification that requires the seller to compensate the buyer for certain tax liabilities

• Holdback funds kept by the buyer temporarily to cover potential tax liabilities

• Closing conditions that require tax settlement before the acquisition can be completed

Consult with legal counsel to develop or review any specific contract language in your deal.

Plan for the potential cash flow impact

You can still acquire a business even if it leaves you with successor liability. The overall assets and benefits may be desirable for a variety of reasons.

If the seller doesn’t want to negotiate terms — or if the negotiation still leaves you with some liabilities — you can integrate all aspects of the deal into your business operations as long as you have a clear plan for the cash flow impact.

Purchasing a business may come with cash flow concerns beyond the taxes themselves. An assessment, escrow requirement, or professional fees can all divert operating capital during or after the acquisition. These should be considered as you make your financial plan.

Financing business tax liabilities is one tool you can use to address the cash flow impact. A revolving line of credit through Avalara Capital can help you cover tax obligations or other costs during a transition in which timing matters.

Protect yourself before closing. Addressing sales tax exposure and tax obligations in your purchase agreement clarifies your liability so you don’t run into any surprises. Setting up a trusted financing tool gives you flexibility to deal with your new assets and obligations.

Explore Avalara Capital to manage cash flow needs related to compliance and growth.

Bret Lawrence, Head of Content for Embedded Finance and Avalara Tax Desk contributor, writes about working capital and the challenges tax debt can pose to accounting and business professionals.