Stock Sale and financial liability
September 29, 2023
by a searcher from University of South Carolina - Darla Moore School of Business in Charleston, SC, USA
I am in LOI on a deal which needed to be done as a stock sale. In due diligence, finding that the seller did massive amounts of personal expenses through the business. It amounts to about $250K/year for 3 years in a row.
My CPA and attorney both say that it is possible to limit liability and potential penalty from IRS for such a situation, however I'm not convinced. Again, it's a stock sale and it is a concern.
Obviously, there are potential liabilities for other aspects of the company which the lawyer working on checking.
What are everyone's thoughts on this?
from University of Minnesota in Minneapolis, MN, USA
Also, keep in mind that the statute of limitations for tax issues can be very long (3 years/6 years/never, a good summary here: http://www.woodllp.com/Publications/Articles/pdf/13_IRS_Statute_of_Limitation.pdf) so a holdback that adequately covers you is easier said than done. Seller will not likely be excited about your proposal to hold part of the purchase price for 6 years, of that I am fairly certain.
In the absence of this, a tax indemnity in a PA needs to be very carefully worded, and I would make darn sure the beneficial owner of the Company is liable under the PA. It will be a huge headache in the event of an audit/issue, but presumably you can likely avoid the liability - just be aware it's not likely as simple as forwarding the audit on to your Seller and letting them handle it.
I would love to hear a war story from someone who has dealt with a Seller tax liability/audit rearing it's head post-closing. It would be extremely valuable (albeit anecdotal) to the community.
The tough part Seller needs to understand is that when you get cute on taxes, you likely pay the piper eventually. Go into this situation with your eyes wide open.
from Wake Forest University in Houston, TX, USA
1. Have reps/warranties/indemnities in place that the seller will maintain responsibility for any prior tax liabilities.
2. If possible, have some kind of hold back that gives you leverage if you have to lean on it (seller note in my case, with language that any future valid claims agains the reps/warranties/indemnities can be offset against your liability
3. If the target is an S-Corp, then the tax documents will clearly show that the seller was the beneficial owner in the prior period where a theoretical IRS audit would discover an issue, and that liability would flow right back to that beneficial owner. So in that case, you might have to deal with the hassle of dealing with the audit, but you wouldn't be responsible for any liability ultimately determined.