I was chatting with an old friend, and he was telling me a sales tax horror story that deserves repeating here. It involves bulk sales (ie. the sale of a business as a whole - lock, stock and barrel, as it were).
Don (not his real name) wanted to expand his computer business. He was based in Illinois, and heard about Arnie, who was in New York. Arnie said he wanted to retire and cash out. Don and Arnie both got their attorneys involved, and Don had his CPA thoroughly review Arnie's books. Don thought he had been very careful. And, because Don was buying the entire business including the inventory, fixtures, equipment, customer list and even keeping the employees on, it was a bulk sale. After the sale was closed, Arnie retired to his new boat in the south Pacific.
A short time after the sale, the New York Department of Taxation and Finance showed up to do a sales tax audit. And they assessed Don, the new owner, for $1,550,000 in sales taxes, almost all of which applied to sales that happened long before he had even heard of Arnie.
You see, Arnie had not been collecting tax on his sales of computer services. Hardware? Yeah, he was collecting on that. But not on the repair labor, which is taxable in New York. And Don, who was from Illinois where those services aren't taxable, didn't even think of this when he took over the business. He continued to make the same mistakes that Arnie had made.
Because Don had bought Arnie's business as a bulk sale, he bought everything from Arnie including any sales tax liability that Arnie had acquired. Don had to write a check to the state of New York that was more than half of the check that he had written to Arnie.
When you buy a business, and it looks like a bulk sale, the state will generally hold the new owner responsible for any sales and use tax debt from the previous owner. Even if the previous owner didn't know about it.
The way to avoid this problem varies from state to state. But it usually involves notifying the state revenuers that the business is about to be sold. The state then has a limited amount of time to either notify the parties that there is an outstanding liability, do an audit, or give the buyer a waiver. Remember, the process varies enormously, but that's the outline.
How many ways did this get fouled up?
1. I don't know a lot about business sales, but there's usually not a complete cash out. The new owner holds some of the money back just for this kind of contingency. Don didn't do that.
2. Don and the attorneys and CPA's didn't know about the bulk sale rule. Now they do.
3. Don and the attorneys and CPA's didn't know that repair services are taxable in New York. Now they do.
4. And of course, Don didn't call his old friend Jim. But it never occurred to him because...
5. ...Don didn't know what he didn't know.
The obvious question is did Don try to sue Arnie? Yep. But the former owner was in the south Pacific on a boat and not terribly accessible to the courts of New York.
So Don was, how to say this? Screwed. The business closed about six months later. With that gigantic audit assessment, Don didn't have enough cash flow to keep it going.
Truly a horror story.
The Sales Tax Guy
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Other relevant key words: mergers and acquisitions