This article was written by Thomas Oriet, Esq, LLM, EA, an Of-Counsel attorney who focuses on asset protection, estate planning, and agricultural law at the Law Offices of Casey D. Conklin.
Nobody enjoys talking about taxes but failing to talk about taxes with a person selling their business may cause you to become liable for that person’s tax liabilities. I noticed a few instances where buyers don’t know that they may be held responsible for the acquisition business’s tax liability if the transaction is improperly managed. This article will discuss some observations, a summary of the law, and how a well-drafted escrow agreement can avoid hidden encumbrances you didn’t know when purchasing.
The Problem: Four errors can emerge:
(1) the buyer does not ask about the target company’s tax situation,
(2) the purchase agreement omits a clause obliging the seller to indemnify the buyer against the target company’s (undisclosed) tax delinquencies,
(3) the buyer thinks the corporate shields the individual buyer from personal liability, or
(4) the escrow agreement or purchase agreement fails to comply with the statutory requirements.
We also find that buyers further entrench themselves as the liable party by simply signing a company tax return or cheque to pay taxes when that company still owed money before the acquisition.[1]
The Law: Michigan Compiled Laws 205.27a makes a corporate officer or members personally liable if the purchased business fails to pay its sales, use, tobacco, motor fuel, and motor carrier fuel taxes.[2] Cities, such as Grand Rapids and Highland Park, can shift the tax liability to the purchaser as well.[3] The purchaser also becomes liable for outstanding unemployment tax liability. However, unlike the other tax statutes, the seller or their agent, such as a real estate broker, must disclose to the buyer on UIA Form 1027 the seller’s outstanding unemployment tax liability, tax payments, rates, and benefits charges for the past five years.[4] Furthermore, a seller’s failure to disclose is a misdemeanor that may result in imprisonment and any consequential damages that the buyer incurs.[5] The buyer remains liable for the unpaid unemployment taxes, but at least, the tax statute recognizes the buyer’s innocence in acquiring the property. It’s interesting how a buyer is safeguarded for unemployment taxes, but not other Michigan taxes, resulting in more litigation of MCL 205.27a due to the many taxes it encompasses. Ancillary issues can arise to make a bad situation worse. If the buyer is a successor to the family business, the successor cannot limit its liability to the fair market value of the property because the transaction was a familial transaction: hiring an appraiser may be necessary.[6] This unrestrained liability, since they concern excise taxes, may also be nondischargeable in bankruptcy.[7]
Solution: Besides having an attorney review the closing and acquisition documents, a good escrow agreement and account can prevent the buyer from assuming the seller’s tax liabilities.[8] An escrow account has an agent hold a portion of the sale proceeds until the seller satisfies legal obligations that occur after the closing. The buyer’s objective is to have the sales proceeds held in the escrow account after the sale equal the amount of the target business’s unpaid taxes, interest, and penalties. The sales proceeds stay in the escrow account until “(1) the former owner produces a receipt from the [the Michigan Department of Treasury or City Treasurer managing city income taxes] showing that the taxes due are paid, or (2) the former owner produces a [tax clearance] certificate stating that taxes are not due.”[9] Afterwards, the certificate or receipt is delivered, the sale proceeds will be released and dispersed to the former owner of the sold business, and the buyer has not taken on the former owner’s tax liabilities.
Conclusion: As with any large purchase, due diligence and asking smart questions are pivotal to make a cumbersome, time-consuming process easy and painless. Hopefully, people will ask tax questions to the sellers during negotiations, in a polite manner, going forward.
Thomas Oriet, Esq, LLM, EA, is an Of-Counsel attorney specializing in asset protection, estate planning, and agricultural law at the Law Offices of Casey D. Conklin.
[** The information in this article is not legal advice and must only be used for educational purposes. Please consult with an attorney before making any decision. The author will not be updating the article due to changes in the law.]
[1] MCL 205.27a(15)(b). See also MCL 141.664a(2). [2] MCL 205.27a(5), (14). [3] MCL 141.664a. MCL 141.503(2) (City individual and corporate income tax rate limits). [4] MCL 421.15(g) (There are other data on UIA Form 1027 that I did not include). [5] MCL 421.15(g). [6] P J Hospitality, Inc. v. Dep't of Treasury, 857 N.W.2d 285, 289 (Mich. Ct. App. 2014); MCL 205.29(3). [7] Rizzo v. Mich. Dep’t of Treasury (In re Rizzo), 741 F.3d 703, 705 (6th Cir. 2014). See also 11 U.S.C. 523(a)(1)(A), 507(a)(8)(E). [8] Assuming the seller pays off the taxes per the escrow terms or purchase agreement. See also MCL 205.27a (At a minimum, an escrow account limits the purchaser’s liability to “the known or estimated tax liability disclosed by the department and held in escrow.”). [9] MCL 205.27a(1), 141.664a(1); S.T.C., Incorporated v. Department of Treasury, 257 Mich. App. 528, 537 (Mich. Ct. App. 2003).