Many years ago we represented several local waste disposal businesses that were bought out by large national firms. The price was negotiated by the parties, and the contracts were largely written by national law firms and given to the seller and to me for review and comment. When we got to the question of Washington State taxes I was surprised that the out of state buyer was, to be frank, clueless. It was unaware, for example, that because the deal was structured as an asset purchase Washington would impose retail sales tax on the substantial amount of the price allocated to tangible personal property (other than inventory for resale). The buyer agreed to pay the sales tax and assured us that it would take care of it. There was no reason to doubt that the buyer would in fact take care of it, but I told my client that because his business was a registered Washington taxpayer the obligation was legally on him to collect and remit the sales tax. Because of my client’s liability if the tax was not remitted I recommended that the sales tax be escrowed and paid directly to the state to protect my client, and that is what was done.
I was most surprised, however, that the buyer appeared unaware of potential successor liability. True, the buyer had done due diligence by looking over the seller’s state tax return file and noting that all returns appeared to have been filed as required, and that the amounts reported for B & O tax purposes was consistent with the amounts reported for federal income tax purposes. And equally true the contract provided that my client would indemnify the buyer if taxes were subsequently assessed for periods before the sale date. But the buyer had not sought a statement of tax status from Revenue, nor to my knowledge did they give notice of the sale to Revenue at any time. Because my client’s business had few activities which required the collection of sales tax it was unlikely that an audit of my client’s account after the sale would produce much, if any, liability, and because my client had the money to pay any assessed amount, it was harmless to the buyer that the matter passed without discussion. But we continue to see cases of successor liability in large amounts and the plain fact is that in many cases the buyer is caught unaware by a large liability and is left to search out the seller, who may have left the jurisdiction or may deny liability for the new liability. A well informed buyer must understand successor liability for state taxes, and must take steps to protect itself for assessments which are made after closing.
What is Successor Liability?
Potential buyers of a business usually know to search out whether there are liens against the business they are buying that may attach to assets being purchased. A records search for tax liens makes sense where the buyer is concerned only with potential federal tax liabilities, as might be the case where, for example, IRS has filed a notice of federal tax lien for payroll taxes the seller owes. While the absence of a filed tax lien does not rule out the possibility that IRS has a “secret” lien against business assets which it has not yet filed, a purchaser for value without notice usually takes clear of the secret lien. But Washington’s successor liability is a different kind of animal.
The difference is that successor liability does not have its origins in lien law – a lien gives the world notice that assets are already encumbered by security interests or judgments: successor liability has its origins in the Bulk Transfer Law, long since repealed in Washington State, but persisting in slightly different form in the excise tax successorship law. The Bulk Transfer law gave creditors the right to notice of a pending sale of assets, an opportunity to object if no such notice was given and the opportunity to invalidate the sale as applies to those creditors. Its purpose was to protect those who may have extended credit in reliance on the assets of the business. It has now been repealed in many jurisdictions including Washington State, but the idea that the state is a creditor of the business for taxes persists in the tax law of Washington. Moreover, Washington’s successor liability law may makes a successor liable for the seller’s taxes in excess of the value of the assets the buyer received in the purchase.
Basically, the successorship law makes a buyer liable for taxes due on the seller’s business taxes under certain circumstances. A successor is defined by statute as one who (for our purposes) buys more than fifty percent of the fair market value of either the (i) tangible assets or (ii) intangible assets of the taxpayer; . . Tangible assets include equipment and inventory (but not realty), while intangible assets is broadly defined to include intellectual property, goodwill and “exceptional management.” The law makes a successor liable for any tax due from the seller of the assets unless the successor gives written notice to the department of revenue of such acquisition and no assessment is issued by the department of revenue within six months of receipt of such notice against the former operator of the business and a copy thereof mailed to the successor or provided electronically to the successor in accordance with RCW 82.32.135. (see, RCW 82.32.140(4)). Revenue provides a form of notice the buyer can use online.
The statute also states that: If the fair market value of the assets acquired by a successor is less than fifty thousand dollars, the successor’s liability for payment of the unpaid tax is limited to the fair market value of the assets acquired from the taxpayer. The burden of establishing the fair market value of the assets acquired is on the successor.
This is a statute of astonishing breadth. Consider this fact pattern: Bill’s, LLC buys all of the assets from Sally’s corporation which runs three successful bar/restaurants in 2015 for $785,000. The LLC makes a large down payment and pays off the balance of the purchase price in 2016. Bill does not notify Revenue of his purchase of the business assets. In 2016, after Bill has paid Sally off, Revenue audits Sally’s corporation for the period 2012-2015. Revenue determines that Sally had failed to have post proper signage stating that sales tax was included in the price of drinks, and that Sally had understated income in state excise tax returns. The amount of the assessment was $185,000, exclusive of penalties and interest. Immediately after learning of the audit results Sally leaves town. Revenue electronically provides Bill a copy of the assessment in accordance with statute. What is Bill’s liability, if any?
Bill’s LLC, but not Bill individually, is liable for $185,000, the tax timely assessed against Sally’s corporation, but not the penalties or interest included in the assessment. Because Bill never gave Revenue notice of his LLC’s purchase there is no 6 months time limit on assessment of successor liability other than the timeliness of the assessment against Sally. Because the purchase price exceeded $50,000 Bill’s corporation is liable for the entire tax amount.
What could Bill have done? (1) Better due diligence might have alerted Bill to understated income in returns and might have led him to question whether Sally was properly advertising that the price of drinks included sales tax. (2) Bill might have given Revenue notice of the purchase which would have limited his exposure to an assessment made within 6 months from the date of notice. (3) Bill should have held back a reasonable amount from the purchase price to cover possible tax liability. But, the reader will recognize that Bill does not anticipate the assessment or its amount, so as a practical matter he has no idea of how much to withhold.
This is a tough law, with little leeway. If you are purchasing a business do not overlook it.
Learn more about tax lawyer Martin Silver.