Buying a Business? Beware of Hidden Tax Liens
The prospect of buying a business is exciting. However, it also presents numerous traps and pitfalls for the inexperienced person. Having a purchase agreement is not everything you need to protect yourself in the event something goes sideways. While the risks of do-it-yourself business purchases are too numerous to address here, we’ll discuss a big one below: hidden tax liens.
Unhappy Surprise for Purchaser of Pizza Shop
We’ll start with a true story of a small business purchase that went bad. John’s dream was to own a restaurant. He bought a pizza restaurant that was a local favorite from the owner who was tired of running it. Included in the deal was all of the equipment and supplies you’d typically associate with a restaurant – pizza ovens, kitchen appliances, tables, chairs, etc. Several months after he had taken over, he received a tax lien notice from the Department of Revenue advising him of a variety of unpaid taxes. It was a shock to him because he had paid all of his taxes on time. After calling for an explanation, he realized that the unpaid taxes predated the time when he became the owner of the business. Making matters worse, he was advised that the taxes were liens on the assets that he purchased. If he failed to pay the taxes, the state could sell his equipment to satisfy the debt. The prior owner didn’t return his calls and he was stuck having to deal with the problem or lose his business.
What is a Tax Lien?
Pennsylvania businesses pay a variety of taxes, including sales, payroll and income taxes. The failure to pay these taxes in a timely fashion can result in a lien. A lien is defined as a charge on real or personal property owned by the business for the satisfaction of debt or duty. The Department of Revenue files a lien with the county Prothonotary Office when a business (or business owner in the event of a sole proprietorship) has unpaid delinquent taxes. When a lien is filed, it becomes a matter of public record. The lien ensures the Commonwealth of Pennsylvania is listed as a priority creditor that must be paid before other financial transactions can take place (real estate sales, business transfer, obtaining a loan, etc.). The department files liens for all types of state taxes: corporation taxes, sales & use taxes, employer withholding taxes, motor fuels taxes, realty transfer taxes and various other taxes.
Why Should Business Purchasers be Concerned About Tax Liens?
The lien attaches to the assets at the time the lien is filed. When you buy the assets, you buy them subject to the tax lien. The sale of the assets to you does not make the lien go away. Even more troubling is that the lien can attach to the assets after they are purchased. The lien attaches to the assets no matter who owns them at the time the lien is filed. If the delinquent tax is not satisfied, the state could force a judicial sale of the assets to pay the amounts due. So long as the tax lien remains unsatisfied, you may have difficulty selling your business or using the assets as collateral for business loans.
How to Protect Against Hidden Tax Liens
The good news is that tax liens are almost always avoidable by doing some homework prior to closing on a business purchase. The five steps you should take include:
1. Due Diligence
Due diligence is a vital step to take when buying a business. A thorough review of the target’s business finances and legal issues is critical to ensure your acquisition is a success. Ask for copies of the company’s tax returns/reports and proof that taxes were paid.
2. Request Tax Lien Certificates
You can request certificates from the Department of Revenue for prior tax periods to determine if there are any unpaid taxes of record. This will cover prior tax periods but not the periods that close after the closing date for your business. These take 7-10 days to obtain so you should plan accordingly.
3. Docket Searches
Check the dockets in the county where the business is located for any liens filed by taxing authorities.
4. Protective Provisions in Sales Agreement
A buyer should make sure that the Agreement of Sale includes representations from the seller that the seller owes no Pennsylvania taxes and a full indemnity by the seller against liability for any such taxes. In addition to a provision in the Agreement of Sale for indemnification by the seller to the buyer for any tax liability, the buyer should also consider holding back money in escrow. Since a seller will most likely distribute the funds it receives from the sale of the business and dissolve the selling entity, personal guaranties of the indemnity provisions and a holdback of a portion of the purchase price should be considered.
5. Obtain a Bulk Sale Tax Clearance Certificate
The Bulk Sales Law offers important protections for business buyers. A bulk sale clearance certificate must be obtained in all transactions involving the sale of fifty-one or more percent of the assets of a business, including real estate. It’s a two part-process.
In the first step, the Pennsylvania Department of Revenue and the Pennsylvania Department of Labor & Industry must be notified in writing 10 days prior to the transfer of 51 percent or more of the assets owned by the target business.
It is important to note, however, that buyers are only protected when they secure a Bulk Sales Clearance Certificate from the seller. The failure of a buyer to obtain a Bulk Sales Clearance Certificate makes the buyer liable for all unpaid taxes owed by the seller up to and including the date of the sale, whether or not the taxes have been settled, assessed or determined at that time. The second step requires the seller to obtain a Bulk Sales Clearance Certificate after the closing The seller must file an Application for Tax Clearance Certificate with both the Pennsylvania Department of Revenue and the Pennsylvania Department of Labor & Industry. The Application for Tax Clearance Certificate should set forth the date of the sale and include a copy of the Agreement of Sale and proposed Settlement Sheet. In addition, the seller must complete and file all tax reports/returns and pay all taxes (including interest, penalties, fees, charges and other liabilities) due to the Commonwealth up to and including the date of the sale. The Department of Revenue can take a year or longer to issue a Bulk Sales Clearance Certificate.
Hidden tax liens noted above are but a few of the pitfalls faced by buyers of a business. A wise businessperson will not attempt to navigate through these potential traps without the assistance of competent legal counsel. The experienced attorneys of Fiffik Law Group, P.C. provide the legal assistance you need to buy or sell a business in Pennsylvania. We’ve helped many small business people buy and sell businesses over the years. Please contact us to schedule an appointment today. You can’t afford not to.