A business can be a valuable asset to acquire – but be careful. If the entity owes unpaid sales taxes to the California Department of Tax and Fee Administration (CDTFA), which administers the state’s sales tax regulations, you could become personally liable. This issue, known as “successor liability,” can be immensely costly for businesses; but with careful and nuanced tax planning, its effects can be mitigated, or even avoided entirely. Before merging with or purchasing a business in California, be sure to work with an experienced business tax attorney, who can exercise due diligence to discover potential off balance sheet tax liabilities. If you have already inherited a business entity’s sales tax debts, a tax litigation attorney may be able to dispute the matter by filing an appeal with the California Office of Tax Appeals (OTA).
In most cases, the answer to this question is yes: in California, the purchaser of a business (called the “successor”) generally inherits the unpaid sales tax debts of the seller (called the “predecessor”), as noted briefly here. If the successor, or purchaser, does not withhold enough to pay off any delinquent taxes, interest, or penalties the predecessor might still owe to the state of California, the successor risks assuming personal liability for the outstanding debt. To reiterate, that includes not only the underlying taxes, but any associated penalties and interest that has accrued.
Fortunately, there are ways to limit or entirely avoid the issue of successor liability in California. The simplest and most effective route is to engage in thorough due diligence prior to purchasing a business, which will ensure that you do not encounter any tax surprises later down the road. The due diligence process varies, depending on factors like risk tolerance and time constraints, but at its core, is essentially an investigation into an entity’s debts and assets. The purpose of due diligence is to accurately diagnose the target company’s financial condition before the buyer proceeds with the purchase. (For example, are there any unresolved lawsuits against the company?)
Other than exercising proper due diligence, California taxpayers can also avoid successor liability by obtaining certain documents from state tax agencies. Depending on the circumstances, it may be possible for the successor (purchaser) to obtain a CDTFA certificate confirming that the predecessor (seller) is not liable for state sales taxes, penalties, or interest, in which case the successor is relieved of responsibility to withhold.
Finally, there is a third way to potentially reduce or avoid successor liability, which is provided by California Sales and Use Tax Law, Chapter 6 (Collection of Tax), Article 7 (Payment on Termination of Business and Successor’s Liability), Section 6814, available here. Section 6814(b)(1) provides the following (italics our emphasis):
“If the… [state] finds that a successor’s failure to withhold a sufficient amount of the purchase price to cover the amount owed by the former owner is due to reasonable cause and circumstances beyond the successor’s control, and occurred notwithstanding the exercise of ordinary care and in the absence of willful neglect, the successor may be relieved of any penalty included in the notice of successor liability.”
If you purchase a business which owes outstanding sales taxes, you may receive a letter from the CDTFA called a “notice of successor liability,” or NOSL, as referenced in Section 6814(b)(1) above. As the title of the form implies, the purpose of an NOSL is to inform the recipient that he or she is liable for sales tax, penalties, and/or interest associated with delinquent California sales taxes owed by the predecessor. As explained in Section 6814(a), you will receive this notice (which will be served on you in person) within three years of the date on which you purchased the business. If the amount indicated on the notice is paid in full in a timely fashion, then “no additional penalty shall apply” to the successor.
If you disagree with the NOSL and do not think you should be held liable for penalties, you may dispute the notice by, as described in Section 6814(b)(2), “filing with the board a statement under penalty of perjury setting forth the facts” supporting your claim. Additionally, Section 6814(a) provides that you “may petition for reconsideration” of the deficiency determination (i.e. the amount determined to be owed). For additional information, refer to our article discussing your recourse when issued a California sales tax liability notice.
If you need assistance with a successor liability, sales tax, or general business tax planning issue, turn to a team of award-winning California tax attorneys & CPAs with more than 20 years of legal, tax, and accounting experience. To confidentially discuss a successor liability or sales tax issue in a reduced-rate consultation with a California sales tax audit lawyer, call the Tax Law Office of David W. Klasing at (800) 681-1295, or contact us online to get started.
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