Protecting Against Inherited Tax Liability
Tax due diligence verifies that a business is current on its taxes and protects the buyer from inheriting the seller's unpaid tax liabilities through successor liability. Depending on the jurisdiction and structure, a buyer can be held responsible for a seller's unpaid sales, payroll, or other taxes if the right steps aren't taken. Tax diligence, and obtaining clearances, is how buyers avoid this costly surprise. Work with a CPA and attorney here.
Whether you're a buyer verifying a business or a seller preparing for scrutiny, get a broker's guidance to keep the deal on track.
Verifying Tax Compliance
Buyers (and their CPA) confirm the business has filed and paid its taxes, income, sales/use, payroll, and any industry-specific taxes. Tax returns are also cross-checked against the financial statements as part of verifying earnings. Gaps, late filings, or discrepancies are red flags that warrant deeper investigation.
Outstanding Tax Liabilities
Diligence uncovers any outstanding tax liabilities, unpaid sales tax, payroll tax, income tax, or liens. These matter enormously because of successor liability: in an asset sale, a buyer can, in some cases, be pursued for the seller's unpaid taxes. In California, for example, a buyer can be liable for the seller's unpaid sales tax up to the purchase price without proper clearance.
Tax Clearance Certificates
The protection is tax clearance. Before closing (usually through escrow), the buyer obtains certificates from the relevant tax authorities (such as the CDTFA for sales tax, EDD for payroll, and FTB for income tax in California) confirming the seller owes nothing, or escrow withholds funds to cover potential liability until clearance issues. Skipping this step can leave a buyer paying the seller's tax debt.
Structure and Allocation
Tax diligence also considers deal structure and purchase-price allocation, which affect the tax consequences for both sides. Asset vs. stock sale, and how the price is allocated across asset classes, have real tax implications (see tax considerations). These are planned with CPAs on both sides. The overarching goal: confirm the tax picture is clean and the buyer is protected. See the full checklist.
Note: This article is general educational information, not legal, tax, or accounting advice. Work with a qualified attorney, CPA, and advisors on due diligence for your specific deal.
Frequently Asked Questions
What is tax due diligence?
Tax due diligence verifies that a business is current on its taxes, income, sales/use, payroll, and industry-specific, and protects the buyer from inheriting the seller's unpaid tax liabilities through successor liability. It includes confirming filings and payments, uncovering outstanding liabilities and liens, obtaining tax clearances, and considering the tax effects of the deal structure and allocation.
What is successor liability for taxes?
Successor liability means a buyer can, in some cases, be held responsible for a seller's unpaid taxes. In an asset sale, for example, a buyer in California can be liable for the seller's unpaid sales tax up to the purchase price unless they obtain a tax clearance certificate or escrow withholds funds. Tax due diligence and clearances protect against this.
What is a tax clearance certificate?
A tax clearance certificate is confirmation from a tax authority (such as the CDTFA for sales tax in California) that the seller owes no tax. Buyers obtain clearances through escrow before closing, or escrow withholds funds to cover potential liability until they're issued, to avoid inheriting the seller's unpaid taxes through successor liability.
Do you need a CPA for tax due diligence?
Yes, tax due diligence should involve a CPA and often an attorney. Verifying tax compliance, uncovering liabilities, coordinating clearances, and planning the tax-optimal deal structure and purchase-price allocation are technical areas with significant financial consequences, so professional advisors are essential to protect the buyer and structure the deal well.
Protecting Yourself From Tax Surprises?
Martin Navarro helps buyers coordinate tax due diligence and clearances so you don't inherit the seller's liabilities. Let's talk, confidentially and with no obligation.
Request a Confidential Consultation Call or text: 818-633-3254 · 365navarro.martin@gmail.com