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Sales Tax Issues to Consider When Buying a Business in California

Rex Halverson

People who are interested in buying a business often think about a number of things, namely the money they hope to make and the plans they intend to implement. While buying a business is certainly an exciting opportunity, it is also a financial transaction that can involve some significant tax considerations.

In addition to doing your normal due diligence and knowing all of the payroll taxes, income/franchise taxes, sales taxes, property taxes and business license taxes a business pays annually, a prospective buyer must also investigate other types of potential tax liabilities they could face. This can be difficult to accomplish when a seller claims to have paid all of the taxes due but has not yet filed the most recent tax returns for the business.

If you are considering buying a business in California, you will want to make sure that you have legal representation, as well as an experienced tax professional, whether it be a CPA or tax attorney, as the latter will be able to help identify and advise as to how to correct any tax issues so you can complete your purchase in confidence.

Is the Sale of a Business Taxable?

Most sales of a business involve the sale of real estate, assets (both tangible and intangible personal property and inventory) and goodwill to name just a few items. The sale of real estate is not subject to sales tax in California but such a change in ownership will trigger a property tax reassessment. The sale of tangible personal property for consideration will be subject to sales tax unless an exemption applies, like an occasional sale, or no consideration was paid for the property. But, you must be careful as assumption of indebtedness, counts as consideration. The sale of intangible personal property, like goodwill, shares of stock or accounts receivable, are not subject to sales tax as that tax is only imposed on sales of tangible personal property in California. That is not the case in every state as some states tax the purchase or lease of real property and some states tax intangibles. The sale of inventory will also not trigger a sales tax IF the buyer timely tenders a resale certificate to the seller. This is the common practice but it must not be overlooked as attention to detail is critical. The resale certificate MUST be timely tendered.

Most sales also involve either an asset sale or a stock sale. An asset sale will generally be subject to California sales taxes. A stock sale, on the other hand, avoids sales tax imposition since it is a sale of an intangible.  With a little tax planning, assets can be dropped down into a NewCo and the stock of Newco transferred without triggering a sales tax.

Certain exemptions to sales taxes also exist, such as the occasional sale exemption. California Revenue and Taxation Code § 6006.5 defines an “occasional sale” as (a) a sale of property not held or used by a seller in the course of activities for which he or she is required to hold a seller’s permit or (b) any transfer of all or substantially all the property held or used by a person in the course of those business activities when after the transfer the real or ultimate ownership of the property is substantially similar to that which existed before the transfer.

The phrase “substantially all the property” generally means 80 percent or more of all tangible personal property held or used in the course of business activities. Stockholders, bondholders, partners, and other persons holding an ownership interest in a business are regarded as having the real or ultimate ownership of the property of the corporation or other entity under this statute.

The sale of a business that holds a seller’s permit because it makes three or more sales in a 12-month period will generally not qualify as an occasional sale under Revenue and Taxation Code section 6006.5.

Successor Liability and Bulk Sale Notification

When purchasing a business, most buyers think that they will not be liable for the sales and use tax liabilities of the seller. However, in California, we have successor liability. That is, a successor or purchaser of a business or stock of goods must withhold a sufficient amount of the purchase price to cover the sales tax liability of the seller when the purchase and sale of the business or stock of goods is pursuant to a contract, providing for the payment to the seller or his designee of a purchase price in money or property or providing for the assumption of indebtedness and only to the extent thereof. This successor liability includes taxes, penalties and interest, even though the amounts have not been determined.

How to Minimize or Eliminate Successor Liability

If you are looking to purchase a business, you will want to make sure to minimize or eliminate any successor liability issues up front. When it comes to sales tax, successor liability will apply to the corporation’s prior sales to customers and the sale of assets in the acquisition.

In order to minimize any successor liability, the purchaser of the business or stock of goods should request a release from the obligation to withhold the purchase price by obtaining a certificate from the California Department of Tax and Fee Administration (CDTFA) stating that no taxes, interest or penalties are due from a predecessor.  A written request for this release should be mailed to the CDTFA; and, upon receipt of a release signed by the CDTFA, it is effective.  If no certificate is issued by the CDTFA or no notice of the amount of tax, penalty and interest that must be paid as a condition of issuing the certificate is mailed to the purchaser within 60 days after (a) the CDTFA received the request, or (2) the date of sale, or (3) the seller’s records are made available for audit, the purchaser will also be deemed released.

Contact a California Tax Professional Today

If you intend to purchase an existing business, you should take as many precautions as necessary to protect yourself from successor liability. By hiring an experienced California tax professional you will be doing proper due diligence that will allow you to sleep at night and avoid California tax surprises.

Schedule a free initial consultation with Rex Halverson & Associates by calling (916) 444-0015 or fill out a contact form found on our website today. We’re here to answer your questions and assist you in any way that we can.