Tax Liability On Balance Sheet

In reviewing the BS for a commercial janitorial and maintenance company I saw a relatively large FICA and Payroll tax liability that seems to be growing YoY (resulting in a negative Owners Equity). Company averages around $1M/yr EBITDA for at least the last three years and has both w-2 and 1099 janitors. Although the owner understands this liability would remain with him after the sale, I am wondering if this is something that will affect my cash flow in future years and should account for it in my modeling in addition to what's on the P/L (e.g., is there supposed to be additional tax expense that's not there today that I need to account for)? I'm not sure why he wouldn't just pay it down given it seems to be generating healthy cash flow and profit. Thanks!

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professional Walsh College of Accountancy and Business Administration Davenport College of Business, Grand Rapids Detroit College of Business - Warren - 03/19/2021

They are probably taking advantage of the payroll tax deferral and 50% is due[redacted]and the other part[redacted]All of my clients require sellers to pay this off at closing. Payroll taxes are not something to take lightly and depending on the structure can have continued or successor liability. Here is an article on the payroll tax deferral we published:

https://www.plantemoran.com/explore-our-thinking/insight[redacted]employee-payroll-tax-deferral-guidance

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searcher Florida Institute of Technology University of North Florida - 03/19/2021

Thanks Robert, that's a great point and is likely part of the story. But there has been a growing amount on this YoY since[redacted]Any clue why? Is it possible he's decided to not pay, or could there be another valid reason?

Your at the point where your going to have to ask the question.

Even in an asset transaction there can be successor liability for certain types of taxes. Payroll taxes that fall into the definition of "trust fund" taxes have personal liability for responsible persons and those responsible persons could be employees that will continue to work for you.

searcher IMD University of Melbourne - 03/19/2021

You can deduct the tax amount from the sale price. This might actually be a requirement by law in some jurisdictions.
you can also try doing an asset purchase so you don’t inherit liabilities, but check local tax laws. In some places the tax man looks at this as a flee risk for tax collection.
finally, you can try a limited partnership if you can get all employees on it and forget about payroll tax all together. This is a little tricky to do so get a CPA to advice

Thanks Uzoma - definitely some good options if I decide to move forward.

intermediary Marquette University - 03/20/2021

Besides the balance sheet issue be careful and get an opinion on the 1099 workers. This is a red flag to government agencies. Your CPA or attorney should have a checklist of what criteria makes someone a W-2 or[redacted]Also ask if the seller has an opinion stating they comply with 1099 rules.

intermediary The University of Chicago - Booth School of Business Illinois Institute of Technology Cleveland State University - 03/23/2021

1) As Bob Shefferly said, it could be due to recent rules on payroll tax deferral.
2) Can't explain the 2018, 2019 increase unless it has to with converting 1099 to W2, or IRS going back and reversing 1099.
3) Such accrual should not impact EBITDA and equity account.
4) Increase in payroll tax liability should result in increase in cash balance or a significant decrease in other liability (like debt).

searcher Florida Institute of Technology University of North Florida - 03/24/2021

Thanks all for the input and areas to dig - as always, very insightful

admin Massachusetts Institute of Technology - MIT Sloan School of Management Taylor University Stanford University - Graduate School of Business - 03/25/2021

Tagging a few additional accounting friends that might be able to provide additional context on the payroll tax liability issue:

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To our accounting friends, THANK YOU for helping to make Searchfunder a collaborative community! You can improve your organic rank in the Searchfunder Directory by staying active and by having your Searchers review/endorse your profile. PM me with questions.

Be sure to take full advantage of your UNLIMITED access to BVR Deal Stats, now available under the VALUATIONS tab at the top of this screen. Here is the direct link:

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With Best Wishes, ^[redacted]‌

professional Villanova University - 03/25/2021

The payroll tax deferral was permitted from March 27, 2020 to December 31, 2020, so if you see it continuing to build after year-end, you know you have another factor at play here. Another thought not mentioned above are rising minimum wage and to a larger degree a general increase in wages. So if there is a rise in wages and the business is growing, you would expect to see payroll tax liability and other payroll liabilities increase. The Seller could also be accruing for bonuses and associated payroll taxes. Lastly, be sure to ask how they accrue for these items and get an example calculation. Given pay period and pay date cadences, it's possible they are doing it incorrectly. Best of luck and let me know if you need a second set of eyes when you get an answer. [redacted]

like reply | 2 likes

professional Pace University Vassar College - 03/25/2021

I agree with David regarding the deferred employer FICA liability under the CARES Act, but is it more than that. In an asset deal, you should model your pro forma EBITDA and cash flow including payment to the IRS for 100% of withheld FIT and FICA as well as the employer's portion of FICA 7..65% of all wages except those per employee over about $130k (that changes from year to year. Let me know if you have any further questions about how to build this in to your model. [redacted]

professional Ecole Supérieure de Commerce de Bordeaux - 04/08/2021

He didn't pay it down because it's a 0% loan from the Federal government.

TAX LIABILITY ON BALANCE SHEET

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