Tax liabilities a buyer can’t escape in an asset purchase

Blog / The two tax liabilities a buyer can’t escape in an asset purchase

With the pace of merger and acquisition activity taking place in the healthcare industry, tax due diligence—which involves a thorough analysis of the different types of tax liabilities that may exist when a company is purchased or sold—often gets overlooked in asset sale transactions.

Why would this be the case when millions of dollars may be at stake? In most cases, the buyers believe that because they are purchasing assets instead of a company’s stock/equity, they are shielded from any potential pre-acquisition liabilities. That can be a risky and potentially costly assumption.

What are tax liabilities of an asset purchase?

While it is true that buyers may be able to avoid some types of tax exposure with an asset purchase, there are two liabilities they generally cannot escape: sales tax and payroll tax.

In many taxing jurisdictions, any liability associated with sales or payroll tax attaches to the assets of the entity and, in most situations, the buyer can become responsible for paying the liability. These areas of exposure are commonly overlooked during the due diligence process, yet both can negatively affect the outcome of the transaction and the buyer’s bottom line post-acquisition.

In some cases, there also may be substantial penalties added to these tax liabilities, making what appeared to be a great deal much less appealing. The following is an overview of a few potential areas of sales and payroll tax exposure that can exist at the time of acquisition.

Sales Tax

The U.S. Supreme Court’s decision in the Wayfair case from 2018 has given states more power to impose sales tax on out-of-state businesses and has really brought sales tax exposure to the forefront. The Wayfair case essentially eliminated the need for physical presence in a state to create sales tax nexus (i.e. what triggers a filing requirement or collection issues).

Prior to this case, an entity needed to have a physical presence in a state in order for that state to assess sales tax. Now, states are changing their laws around sales tax nexus to be based more on the volume of sales and/or the number of transactions. For example, under the new rules, nexus can be triggered in a state when a business has at least $300,000 in sales and more than 200 transactions.

LBMC performs many tax due diligence engagements and the two biggest issues with sales tax that we are seeing revolve around (a) companies not fully understanding the potential taxability of the product or service they are providing and (b) companies failing to obtain exemption or resale certificates, even if selling to an obviously tax-exempt entity.

Another key point to note is that the statute-of-limitations for sales tax does not start until a tax return is filed. As such, if a sales tax return has never been filed, a state can assess tax, penalties, and interest starting with the first year the company started conducting business in the state.

As a result of the Wayfair ruling and varying state criteria for triggering sales tax nexus, these key areas of exposure have become much more complex, and many businesses have more exposure in other states than they have ever had before. So, make a note to consult your tax advisor specifically on the Wayfair ruling and any implications it might have on your sales tax obligations or opportunities.

Payroll Tax

Payroll taxes continue to be a hot topic with the IRS- especially when it comes to the misclassification between employees and independent contractors. LBMC has also seen states become more aggressive on the collection of payroll taxes on nonresident individuals that work in their state. For example, if a Tennessee employer has an employee working outside of their “home” state in California for a month, the employer may be legally required to withhold California’s payroll tax, file a California return and remit any required withholding. Each state has different laws that determine when a nonresident individual’s employer is subject to nonresident payroll tax withholding, but most impose the withholding once an employee has worked in the state for a specified amount of time (i.e. two weeks, one month, etc.).

In addition, if the company being purchased did not file payroll tax returns, the state’s payroll statute-of-limitations never starts. In such a case, the liability could go all the way back to the company’s formation.

Payroll taxes can really add up and adversely affect a deal. A recent example is a company seeking to make a purchase discovered the payroll tax liability exposure due to employee misclassification was $600,000 over a three-year period. The purchase price was $6 million so that extra $600,000 made a big difference to EBITDA and the overall valuation of the company.

Key Takeaways

If you see an acquisition or sale on the horizon, make sure you identify and quantify all areas of exposure so you can address them on the front-end and ensure you get an accurate valuation.

If you are planning to sell your company or are looking for new investors, it is wise to engage someone knowledgeable in tax diligence matters to perform sale-side tax diligence so that you know your exposure on the front-end and have an opportunity to remedy previously unknown tax liabilities. Such diligence also increases your credibility with prospective buyers because of your foresight and transparency.

On the flip side, if you are acquiring an entity make sure you don’t overlook sales and payroll taxes—they definitely need to be added to your due-diligence checklist. Even if you do not want full-blown tax diligence, make sure you are looking at these two areas.

Whether buying or selling, the key to successful tax due diligence in any acquisition is to make sure you are working with a qualified transaction specialist who knows what to look for and how to work through previously undiscovered tax problems. Such specialists not only can save time, money and headaches, but also bring credibility and objectivity to the process.

Content provided by LBMC professional, Jayme Parmakian.

Jayme Parmakian, CPA, LBMC Shareholder, and tax services leader in LBMC’s transaction advisory services division.

LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.

What are tax liabilities of an asset purchase?

Sales Tax

Payroll Tax

Key Takeaways

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