With an asset sale, many sellers do not realize that escrow will hold proceeds of the sale until all government releases have been received which can take several weeks, unless notified by the buyer. These releases relate to specific tax liabilities with regards to Sales/Use tax, Personal Property tax, and Employment taxes.
Recognizing the need to protect both buyers and creditors, California has enacted various procedures by which a buyer of a business can know that the creditors are either paid off or are barred from seeking relief against the buyer. Bulk Sales Law is designed to protect buyers and creditors. It was written to prevent owners from a) selling businesses to buyers and disappearing with the proceeds, or b) selling under market value (“sweetheart deals”) to avoid paying creditors the full amount owed.
As a good faith gesture, many buyers will notify escrow to hold only a certain amount of funds from seller proceeds at closing to cover any potentially unpaid taxes. The amount held can vary and depend on what potential taxes are owed. Historical taxes paid by the business along with interim financials could be used as a good barometer for determining the amount to hold back. As an example, if the business typically paid quarterly sales tax of $1,000 then it may be prudent to hold back $2,000 to more than cover the potential tax liability. Similar calculations can be performed to determine hold back amounts related to personal property tax and employment taxes.
Sales and Use Tax. Buyer should place in escrow an amount sufficient to cover any tax liability owed to the BOE (Board of Equalization) until the Seller produces a receipt from the BOE indicating that all taxes have been paid or until the BOE issues a “Certificate of Tax Clearance” indicating that no amount is due. If Buyer fails to comply with Notice Requirements and Seller has failed to pay taxes completely, Buyer may become liable for the unpaid taxes.
Personal Property Tax. Bulk Sales may also trigger an additional personal property tax, separate from a deed transfer or recordation tax. The Buyer generally pays this tax going forward, but any unpaid tax is paid by the Seller. If, however, the Buyer fails to provide proper Notice, Buyer will be required to pay the unpaid personal property tax.
Employment Taxes. If Buyer purchases a business with employees, Buyer should also place in escrow an amount sufficient to pay contributions, interest and/or penalties due or owing by Seller for unemployment compensation insurance benefits or disability insurance. As with sales and use tax, the amount withheld is released upon issuance of a Tax Clearance Certificate, in this case issued by the Employment Development Department (EDD). Failure to withhold sufficient funds may result in Buyer’s personal liability for the above payments.
As you can see, there is a win-win-win scenario where the State collects any taxes due, the buyer is protected from any unpaid taxes, and the seller receives the majority of their proceeds at closing and then the remaining part once all clearances are received.