Successor Liability for State Income and Franchise Taxes

Editor: Frank J. O’Connell Jr., CPA, Esq.

State & Local Taxes

A purchaser of assets generally has a reasonable expectation that it will not be liable for the income tax liabilities of the seller. While sophisticated buyers typically anticipate that under certain circumstances they may be liable for so-called trust fund taxes (e.g., withholding, sales tax, etc.), few buyers expect that they will be liable for the seller’s unpaid share of income and income-based franchise taxes.

However, there is a small, but important group of states that provide a statutory basis for imposing such a liability. Unlike the federal rules, the statutes of these states give tax administrators authority to collect the seller’s income tax liability from the buyer even if there is no indication of fraud or an intent to evade tax. (A discussion of the state tax consequences of a deemed asset acquisition under Sec. 338 is beyond the scope of this item.)

Federal Successor Liability

The federal government has a number of provisions available to it to assert successor liability. The most important of these provisions is Sec. 6901. Under Sec. 6901, the federal government may, among other things, hold a third-party transferee of assets liable for the income tax liability generated by the seller. This liability may be established “at law or in equity.” Included, for purposes of illustrating this point, is a nonexclusive list of the ways in which the federal government may assert successor liability:

• Bringing a federal case based on the Federal Debt Collection Procedures Act of 1990, P.L. 101-647, or a state case based on applicable state fraudulent conveyance acts;
• Bringing a case based on the trust fund doctrine, which is effectively an action in court to set aside the transfer; and
• Establishing that the buyer has nominee or alter ego liability.

Aside from the withholding of trust taxes and other situations where the buyer has legally agreed to acquire the liability, the federal government is required to show some indication of fraud or intent to evade taxes in the asset transfer.

State Income and Franchise Tax Successor Liability

A number of states provide a bulk-sale procedure whereby a buyer of assets must report the purchase to the state within a certain statutory time period (and meet certain statutory requirements and make required filings) to absolve itself of successor liability for nearly all outstanding state taxes. In most cases, the liability and the procedure are limited in scope to sales taxes. This item focuses on two states, Illinois and Pennsylvania, that have statutorily included income taxes within the scope of this procedure.

The bulk-sale procedure is not to be confused with the sales tax exemption available in most states that sometimes is called by the same name. States that provide for a bulk-sale sales tax exemption typically exempt asset transfers that constitute all or substantially all of the seller’s assets from sales tax. While both concepts are typically relevant in the context of a sale of assets, the bulk-sale procedure relates to prior liabilities, and the bulk-sale exemption relates to the taxability of the transfer of assets. This item is only concerned with a bulk-sale procedure that relates to prior liabilities.

States generally impose successor liability pursuant to statutes and regulations for sales taxes and other transaction-level taxes, such as gross receipts taxes. Certain states, notably Illinois and Pennsylvania, have statutes that explicitly impose successor income tax liability for those taxpayers that do not engage in the bulk-sale notification procedure.

Illinois: In 35 Ill. Comp. Stat. 5/902, Illinois provides that a buyer may succeed to the income tax liabilities of the seller when a “major part” of the business is purchased outside the usual course of business. A major part of the business is defined as the inventory the taxpayer is engaged in selling, the furniture or fixtures, the machinery and equipment, or the business’s real property. A sale of any one or more of these components constitutes a bulk sale. The buyer may be held liable for the seller’s income tax if the buyer does not notify the state by following the bulk-sale notification procedures outlined in the statute (see 86 Ill. Admin. Code tit. 86, §130.1701, for further guidance).

The applicable regulation, which is concerned mainly with procedure, provides only two examples of situations where bulk-sale reporting is required:

• A store selling clothing and shoes sells the clothing inventory, and, presumably, not the shoe inventory;
• Bulk-sale notification is required at the point when the sales contract is entered into when a company sells its business on a contract-for-deed basis.

Given the broad scope of the language of the statute and the absence of formal guidance, it is prudent for asset purchasers to follow the bulk-sale notification procedure discussed below wherever possible.

Asset purchasers may elect to file the notification at least 10 business days prior to the proposed sale, but they are required to file within 10 business days following the sale. Illinois Form CBS-1, Notice of Sale, Purchase, or Transfer of Business Assets, is used for this purpose. If the asset purchaser fails to notify the Department of Revenue within 10 business days of the purchase, it becomes liable for any outstanding tax amounts. Upon receipt of such notification, the state has 10 business days to issue the purchaser an order to withhold a calculated portion of the purchase price covering pending tax liabilities and 60 business days to finalize an actual amount of taxes, penalties, and interest due. If the Department of Revenue fails to issue these orders in the designated time frame, the purchaser is relieved of successor liability.

Pennsylvania: Pennsylvania tax law 72 Pa. Cons. Stat. Section 1403 provides that a buyer may succeed to the corporate income tax liabilities (as well as other unpaid tax obligations) of the seller when the purchaser buys 51% or more of its stock of goods, wares, or merchandise of any kind, fixtures, machinery, equipment, buildings, or real estate. For the buyer to avoid this liability, the seller is required to provide notification at least 10 days prior to the completion of the sale. Pennsylvania Form REV-181, Application for Tax Clearance Certificate, is used for this purpose.

Along with the notification, the seller is required to remit any known outstanding reports and taxes due to the state through the purchase date. Once this process is complete, the seller is required to provide the purchaser with a certificate from the Department of Revenue, specifically a Corporate Clearance Certificate as outlined by 61 Pa. Code Section 151.4, acknowledging that all reports and taxes are settled. If the purchaser fails to require the seller to produce this certificate, the purchaser becomes liable, as a successor, for any unpaid taxes. The state successfully applied and defended the application of this statute in the case of Pennsylvania v. Qwest Transmission, Inc., 765 A.2d 818 (Pa. Commw. Ct. 2000).

Implications of State Asset Acquisitions

Illinois and Pennsylvania clearly authorize their tax administrators to impose unpaid income tax liability of a seller onto the buyer on the basis of a failure to file a form notifying the state in a timely manner of a sale of assets. Moreover, unlike the federal government, there is no requirement for the state to show fraud or intent to evade tax to establish a liability. As a way to further increase revenue, other states that have a bulk-sale notification requirement for sales tax may attempt to extend the requirement to income taxes, as well.

EditorNotes

Frank J. O’Connell Jr. is a partner in Crowe Horwath LLP in Oak Brook, Ill.

For additional information about these items, contact Mr. O’Connell at 630-574-1619 or frank.oconnell@crowehorwath.com.

Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.