Purchases and sales of businesses operating in the United States offer state and local tax planning opportunities — and trigger exposure to new and historical tax liabilities. The state and local tax risks and rewards are different from those involving federal income taxes, but can involve tax dollars of an equivalent or greater amount. State and local taxes to be analyzed include income, franchise, sales, use, real property transfer and other types of taxes. And, while these state and local tax considerations are often overlooked, they exist in all types of transactions, whether involving stock transfers or asset transfers.
This Alert will be distributed in two parts. Part I highlights important state and local tax issues for purchasers of the stock or assets of another business. Part II will highlight issues applicable to sellers.
I. General Observations for Purchases.
The purchase of a business can create tax presence for the purchaser in states where it did not previously have such a presence. Tax presence is important because it is the first step in creating a tax liability. (Tax presence is discussed in State Tax Alert, volume I, issues 1, 2 and 4.)
Because of the potential expansion of tax presence and tax liabilities, in anticipation of any business acquisition it is advisable to identify the states in which the purchaser and seller have property or activities. It also is important to know whether the seller recently terminated its tax presence in one or more states. After the relevant states are identified, it might be desirable to restructure the purchase prior to closing to avoid the creation of tax presence in one or more states.
In addition, for income tax purposes it is important to identify differences between federal and state tax treatments. For example, the states do not always conform to federal classifications of entities. Mistakenly assuming that a business will be treated as a pass-through entity or will be disregarded for state tax purposes risks a substantial understatement of income taxes. (Nonconformity with federal treatments is discussed in State Tax Alert, volume I, issue 4.)
Additional income, sales and use tax issues to be considered include the following:
II. Asset Purchases.
A purchaser of assets is potentially liable for the seller’s unpaid sales taxes, use taxes and other taxes, as well as for the seller’s abandoned property liability. The purchaser’s liabilities can arise as part of the transaction or because the purchaser is a successor to the purchased business. Unfortunately, purchasers of assets are regularly caught unaware by their exposure for the seller’s unpaid taxes. However, as demonstrated by a November 2005 decision by the State of Texas, the states can and do impose tax liabilities on unsuspecting purchasers. Further, the purchasers may be denied any opportunity to contest the amount of the tax. During 2005, many states published decisions imposing this type of liability on purchasers.
To avoid or at least reduce the risk of such liability, purchasers of business assets should file tax “bulk sale” notices with the relevant tax jurisdictions. These are different from bulk sale notices filed for Uniform Commercial Code purposes, and instead put the state tax authorities on notice of the planned asset purchase so that any such claim for tax liabilities must be asserted before the transaction occurs — at a time when the purchaser can hold the seller responsible for the tax. Additional techniques for minimizing such exposure are available as well.
Purchasers also should determine, prior to the purchase of a business’s assets, whether the affected states have sales and use tax exemptions for asset purchases. (Sales tax exemptions are discussed in State Tax Alert, volume I, issue 2.) If the state has such an exemption, it might be possible to avoid all sales and use taxes on the purchase of the business. Other sales and use tax exemptions, as well as credits, may be available as well.
III. Stock Purchases.
Stock acquisitions obviously present exposure for the seller’s state taxes. This risk can be reduced by determining whether the seller has filed all required returns with the states in which it has tax presence, whether the seller has sold or transferred assets in the last several years and, through contact with the relevant states, whether the seller has any open audits or unpaid assessments.
In addition, if the purchased business owns or leases real property, the purchaser should determine prior to the purchase whether the transaction will be subject to real property transfer taxes. (Real property transfer tax planning is discussed in State Tax Alert, volume I, issue 5.) Other due diligence measures can identify and, perhaps, reduce the purchaser’s exposure for the seller’s other liabilities. For example, states may attempt to hold a purchaser liable for the seller’s noncompliance with state unclaimed property laws (Unclaimed property liabilities are discussed in State Tax Alert, volume I, issue 7). The purchaser therefore will want to know the extent of the seller's compliance with unclaimed property reporting requirements.
Purchasers may be able to negotiate incentive packages with the state and municipality in which their new operation will be located. The incentive packages might involve subsidies, tax credits and other incentives. (Pending United States Supreme Court cases involving tax incentives are discussed in State Tax Alert, volume I, issue 6.)
This Alert highlights some of the state tax considerations when purchasing another business’s assets or stock. For further information and assistance with state and local tax issues anywhere in the United States, please contact David A. Fruchtman at 04-629-0520 or at (312) 281-1111.