How to uncover hidden tax liability ahead of the sale of a business

Business owners are selling their closely held businesses at high rates as many reach their ideal retirement age without a successor to carry on the company. They’re facing a once-in-a-lifetime liquidity event that has the potential to provide generational wealth to the owner and their family.

However, while the payoff to selling a business can be great, there are pitfalls.

“Hidden tax liability can be a big problem in the sale of a business,” says Kerilyn Boergert, a principal at Clark Schaefer Hackett. “If a company’s unrecognized tax liability is discovered by a buyer, it could negatively affect the company value, or cause the deal to fail.”

Smart Business spoke with Boergert about the importance of sell-side diligence to uncover and understand tax issues before selling a closely held business.

What should sellers look at through tax due diligence?

There are areas of tax that could create greater risk for sellers and opportunity for buyers. The first is tax attributes. Analyzing the tax attributes of a business through the sell-side process can be valuable to a seller when it poses a potential benefit to the transaction. Attributes such as net operating loss carryovers, business credit carryovers, minimum tax credits, capital losses, and the impact of any PPP loans and the employer retention tax credits should be considered.

Employment tax can be a risk for sellers. Tax authorities are increasingly focused on the misclassification of employees as independent contractors. There can be significant tax penalties or interest if a misclassification is identified in an audit.

Sales and use taxes continue to be an increasingly complicated area where pitfalls can occur. The landscape of sales and use tax changed overnight when the U.S. Supreme Court rendered a close 5-4 decision in South Dakota v. Wayfair, overturning the physical presence standard for the sales and use tax nexus that had been in place for 26 years. The Wayfair case changed the sales and use tax arena, making both more complicated for businesses that sell into multiple states. In some cases, those obligations are overlooked, creating historical tax liability for the business and potentially impacting a potential sale.

Even before the dust settled regarding the sales tax implications of Wayfair, states began expanding their interpretation of nexus as it related to income tax. Although economic nexus standards existed in some states, the trend has and is expected to continue as states continue to look for money. Failure to file income tax returns by sellers can pose risks for buyers that they may not want to deal with and could lead to a failed transaction.

What problems can tax issues cause in a sale?

Ignoring or deemphasizing tax due diligence ahead of taking the company to market for a potential sale or private equity investment can lead to significant transaction erosion — a buyer lowing the value of the business — a failed transaction or lost time and distraction from normal business operations. Sellers who don’t have their books and records in order will have a lot more effort to put in during diligence. Sell-side due diligence prepares sellers for negotiating the highest price possible with buyers and helps to avoid common pitfalls that can impact the deal.

How far in advance of a sale process should a seller consider tax due diligence?

It’s highly advisable to assemble a transaction advisory services team. This specialized team offers services, which include financial due diligence, tax due diligence, and tax structuring.

Ideally, the tax due diligence process should begin three to five years in advance of when an owner would like to sell the company. The benefits of tax due diligence and advanced preparation before a sale include optimal transaction value, exposure of transaction risks and potential liability, opportunity to assess oversights in advance of entertaining buyers, increased negotiation power, enhance control and credibility throughout the transaction cycle, and higher probability of closing the transaction. If any issues are uncovered during diligence, especially in tax diligence, there will be time to correct potential areas of concern prior to buyers becoming involved and can lead to maximizing the value of a business for the seller. ●

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Kerilyn Boergert



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