Successor liability for state and local taxes in acquisitions
It is commonly understood that buyers of stock or similar ownership interests in a business will inherit all of the known and unknown liabilities of that business along with its ownership interests. All historical liabilities, including tax liabilities, continue after the transaction since the legal entity remains in existence and is responsible for its liabilities. If assets are purchased, there generally is not continued liability for federal income tax purposes. However, simply buying the assets instead of the ownership interest will not necessarily relieve the buyer of all of its historical or transactional exposure.
Many states have laws in place that transfer the liabilities of the seller to the buyer when substantially all the assets of a business are sold. This can include the selling of a division, location, or product line as well. In many cases, these statutory provisions are imbedded in the state sales tax law. However, some states transfer all tax liabilities and not just the sales tax. Even though some states do not have statutory successor liability provisions, they still often aggressively pursue the collection of historical or transactional liabilities from the buyer by using other legal doctrines. Whether the economy is struggling or booming, states have an interest in collecting revenue that is owed, and it is generally much simpler to seek payment from the current operations of the business than attempting collection from a former owner who is no longer doing business in the jurisdiction or even in existence.
Mitigate successor liability
Many states provide specific guidance on how a purchaser may avoid successor liability. The guidance usually includes two main actions, 1) withholding of an escrow to cover potential unpaid taxes, and 2) the filing of tax clearance requests with the state to support that no taxes are due by the seller. In general, when one or both of these actions are not taken by a purchaser, the purchaser remains liable for unpaid taxes of the seller. It is key to adhere to the timing requirements in each state. In some cases, the states require the reporting or request for tax clearance to occur prior to the transaction such as in New York or Pennsylvania where a 10-day advance notice of the transaction is required to be filed by the seller. All states do not provide for statutory relief from successor liability. In those situations, the attorneys involved with the deal should be particularly mindful about providing for protections in the transaction documents, such as the representations and warranties provisions. In addition, buyers should attempt to negotiate appropriate escrow amounts to cover anticipated cash flow requirements after the transaction closes. If appropriate planning is conducted, the liability of the historical business may be limited through voluntary disclosure agreements, amnesty programs, or similar state procedures.
Buyers should have a good understanding of the successor liability rules for the states in which a target company is operating since there may be successor liability even in an asset transaction. It may be possible to mitigate this exposure by withholding sufficient tax from the sales proceeds and seeking a tax clearance. If liability is not mitigated, buyers should protect themselves in the transaction documents and review the applicability of incentives such as voluntary disclosure agreements and amnesty programs to cost effectively deal with the underlying tax issue.