Successor Liability: You May Be Liable for Unpaid Business Taxes When Buying a Business
If you rush into buying a business you may receive a nice little gift from the State of Connecticut. Except it’s not a gift, it’s a bill, for the unpaid state tax liabilities of the previous business owner. That is because Connecticut has Successor Tax Liability for unpaid state business taxes, but the liability is avoidable.
What is Successor Liability?
Successor Liability is a statutorily created obligation for the Buyer (“successor”) of a business to hold, from the purchase funds, any amounts of business tax that are owed and unpaid by the Seller at the time of the sale, and use it to pay off the Seller’s tax debts to the State. If the Buyer fails to do so, they are liable for those unpaid business taxes.
What taxes can a Successor be liable for?
The Buyer of a business can be hit with successor liability for Sale and Use Tax, Admissions and Dues Tax, and Income Tax Withholdings.
This would theoretically apply to both amounts that were collected and not remitted to the State and amounts that should have been collected but were not. The successor liability also extends to penalties and interest on the unpaid tax amount.
What kind of business succession transactions give rise to successor liability?
Successor Liability will be created when:
- one or more persons buy the business or stock of goods of a seller
- a co-owner quits or transfers ownership for little or no consideration
- a change in the form of ownership occurs
Successor Liability does not arise when:
- transfer of a business or stock of goods is part of a foreclosure, repossession, bankruptcy or receivership
- the purchase is of a controlling interest in a business entity
Is there a limit to the amount of successor liability?
The Buyer is liable for the unpaid business taxes of the Seller ONLY to the extent of the purchase price, valued in money.
The “purchase price” could involve cash, property, assumption of liabilities, cancellation of debt, and the taking of property subject to liability.
So, if the Buyer is receiving a business, in exchange for $10,000 cash, a Derek Jeter rookie card valued at $1,000, the assumption of liability for two outstanding small claims cases (max payout $5,000 each), the forgiveness of $500 in debt owed by Seller to Buyer for a lost bet on the Super Bowl, and the assumption of a $200,000 mortgage on the business property, the Buyer would potentially be liable for up to $221,500 of unpaid business taxes of the Seller.
How can Successor Liability be avoided?
This is the million dollar question. How does a Buyer protect themselves from being liable for the Seller’s unpaid business taxes?
The short answer is that the Buyer needs to meet their obligations under Connecticut law and withhold any tax amounts owed by the Seller. But how does that Buyer know if the Seller owes the State of Connecticut any taxes and the amount owed?
It is the Buyers responsibility, or the responsibility of their appointed agent, to request Tax Clearance Certificates for each type of business tax they want to be protected against owing. The State will review the file of the Seller, and either issue a Tax Clearance Certificate stating that no taxes are due, or an Escrow Letter, telling the Buyer how much money needs to be withheld from the purchase price to pay off the Seller’s state business tax liabilities.
Of course, if an Escrow Letter is issued, the Buyer still needs to follow through with holding onto the funds and actually paying off those tax liabilities or they are still on the hook.
At G&G Law, LLC, our business attorneys represent Buyers in the purchase of businesses and business assets. Part of our job is doing the due diligence necessary to protect the interests of our clients and minimize their exposure to liability. For all our business purchase clients, we take on the responsibility of getting Tax Clearance Certificates for the business tax liabilities our clients may be exposed to. If an Escrow Letter is issued instead, we make all parties aware of the unpaid tax debt, make arrangements to hold the necessary amounts in escrow, and follow through with paying off those business tax liabilities.
Successor Liability is just one of the considerations when buying a business or business assets. If you are in the process of buying a business or business assets, schedule a free 20 minute phone call with one of our business attorneys to discuss your goals and needs.