Module 14-: Buying an established business can be a smart way for individuals to break into a new market without having to face the struggles that come with starting a new business from scratch. For corporations, it provides an avenue to expand capacity, workforce and market share, or move into new markets. When implemented properly, this strategy can be fulfilling and financially rewarding
However, as alluring as the ideal of buying a business might seem, this strategy usually carries tax implications for the buyer, which range from employment taxes to state tax liabilities.
If you are looking to buy a business and have found what seems to be your ideal target, you need to first hire a tax attorney before signing the purchase agreement. The attorney will help you review the seller’s financial documentation, including federal, state, and local tax returns. This will help you understand the tax liabilities you will have to deal with if you eventually take over the business. This step is very critical, as neglecting it can put you at the risk of huge tax liabilities years after buying the business. You sure don’t want that.
Although the tax implications of business acquisitions vary from business to business, some tax liabilities would apply in all cases. And you need to understand these general tax implications of buying a business, even if you don’t know jack about business law. Having this understanding can help you make well informed decisions about business acquisitions.
The Tax Implications of Buying a Business
1. Overview-: When you buy a business, you don’t have to pay federal tax on your purchase. The seller or owner of the business has to continue to pay any tax debts to the Internal Revenue Service (IRS), unless the IRS has placed a tax lien on the business that is transferable with the sale.
However, you will most likely be responsible for other local and state tax liabilities, which vary depending on the structure of the target business. If your target business is unincorporated, your tax liabilities will be less because buyers normally acquire only tangible assets that carry easily quantifiable tax obligations, such as equipment.
But if your target business is corporation, the corporate stock can place huge tax liabilities on you because most stock acquisitions free the seller of all current and future tax obligations (unless otherwise stated in the sales contract).
2. Local and state tax liabilities-: Before now, if the seller owed taxes to state and local agencies, he will still be liable for the taxes even after the sale. But the rule has now changed because government entities have become cash-strapped and are devising various methods to capture tax liabilities without delay.
So, government entities now turn to business buyers during the escrow process and request them to pay the taxes due on their target businesses. In fact, in some states in the U.S., you cannot conduct business after buying a new company until you have paid all outstanding local and state tax debts due on the company. However, you do not have to bear this burden. Before going deep down the acquisition process, you can request that the seller settle all tax debts due on the business and provide certified letters from tax agencies as proof.
3. Taxes on tangible assets-: If you are buying a business’s tangible assets such as machinery and equipment, you or seller may be required to pay local and state sales and use tax liabilities. How the assets are valued determines who will bear the greater part of burden.
Provided the assets are worth a very high value, the tax burden on you will be reduced because you can take a large tax deduction on the asset’s depreciation. However, most sellers will attempt to reduce the value of the business’s hard assets in order to reduce tax liabilities on any assets sold for more than their depreciated cash value. You must negotiate a fair price with the seller on the business’s tangible assets to reduce the tax implications for both parties.
4. Employment taxes-: The law regarding employment tax varies by state. But typically, the burden of employment taxes lie on the business owner.
You can take advantage of employment tax deductions if the business will remain in the business temporarily as a paid employee in order to provide training. In this case, a smart way to reduce your tax liability on the total acquisition would be to negotiate a lower selling price for the business, but in exchange pay the seller a higher wage during the training period.
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