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ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – SBE AND EDD SUCCESSOR LIABILITY OR LOSING IT ALL AND DRIVING THE CLOWN CAR

By Robert S. Schriebman
2020

Introduction

There is an expression used when confronted by people doing silly things, “Who is driving the clown car?” This expression hit me in the face after I read the Office of Tax Appeals’ decision in the Welker case. (In the Matter of the Appeal of Todd A. Welker, OTA Case No. 18011891, issued March 5, 2019)

The Welker case is a sad example of how a combination of impatience and downright stupidity can result in an economic disaster of major proportion. While the case involves debt owing to the former SBE, its principles can have the same results when purchasing a business that owes the EDD. In this article, I will discuss the facts and OTA decision in the Welker matter. I will then show you how the case can apply to the EDD, and hopefully you will take the steps necessary to protect yourself when buying an entire business or a portion of a business, and avoid the Welker disaster. There is an expression used when confronted by people doing silly things, “Who is driving the clown car?” This expression hit me in the face after I read the Office of Tax Appeals’ decision in the Welker case. (In the Matter of the Appeal of Todd A. Welker, OTA Case No. 18011891, issued March 5, 2019)

The Welker Case

The Welker case involved the sale of a restaurant in Santa Monica known as 17th Street Café. My wife and I loved going there whenever we visited Santa Monica. One day we found a different restaurant operating out of the same space. After reading the Welker case, I understand why our favorite restaurant was no more.

The 17th Street Café, Inc. operated without paying its share of sales taxes. It owed the SBE over $440,000! The restaurant was for sale and Mrs. Welker very much wanted to buy it. There was much negotiation and several payment proposals that we need not go into. The purchase price was $710,000. Mrs. Welker and her husband, Todd, put down $238,000 and made arrangements to pay the balance of $485,000 in monthly installments.

An escrow was opened with a very experienced and professional escrow company. The escrow company, in writing, cautioned Mrs. Welker to contact the SBE and obtain a Tax Clearance Certificate before closing the deal. The escrow company so advised Mrs. Welker, TWICE!

Ignoring the escrow company, the Welkers “damned the torpedoes and went full speed ahead.” They insisted on closing the escrow and owning the business. They were not concerned about any Tax Clearance Certificate or equivalent.

As escrow was closing, the Welkers formed an LLC known as Smoochie for the purpose of transferring the restaurant business to Smoochie after the close of escrow. Eventually, Smoochie owned the assets of the restaurant. The Welkers knew about the back sales taxes, but wanted Smoochie to be responsible for the payment. As we will soon see the driver of the clown car just turn on the ignition.

After the close of escrow, things went from bad to worse and the Welkers and seller got into litigation. They settled the matter by the Welkers giving back the business after two years of operation. In the meantime, they had paid the seller $238,000 plus monthly installment payments on the note.

The Welkers never applied for a Tax Clearance Certificate because of their impatience to become a restaurant owner. Meanwhile, the $440,000 of back sales taxes was accruing interest.

Enter the Sales Tax People

Just to recap, to give back the business to the buyer, the Welkers lost well over $238,000 out of pocket. The seller took some of the Welkers’ money and paid down $120,000 of the $440,000 in back taxes. The rest of the money paid by the Welkers was unaccounted for. So when the Welkers took over the business, there was over $320,000 of unpaid sales tax deficiencies. The sales tax people realized that they were not going to get paid by the seller, so the next target of opportunity was the Welkers. The SBE demanded that the Welkers pay these back taxes; even though, the Welkers no longer owned the business.

The bottom line: the Welkers lost everything. They walked away from all the money they paid the seller, and they walked away from the business. Now, they have no business and they are out of pocket of over $238,000. Do they still have to pay the back SBE taxes? YES! The SBE issued a personal assessment against them. “Who’s driving the clown car?”

The Welkers appealed the SBE personal assessment to the Office of Tax Appeals (OTA). Here was what the OTA had to say.

The OTA Decision

California Revenue and Taxation Code § 6811 states, “If any person liable for any amount under this part sells out his business or stock of goods or quits the business, his successors or assigns shall withhold sufficient of the purchase price to cover such amount until the former owner produces a receipt from the (B)oard showing that it has been paid or a certification stating that no amount is due.”

If a buyer fails to withhold from the purchase price as required by § 6811, the buyer becomes personally liable to the extent of the purchase price (R&TC § 6812(a)). It is clear from the facts that the Welkers ignored two written warnings from the escrow company to obtain a Tax Clearance Certificate before closing escrow. However, the Welkers ignored these warnings probably because they were so impatient to go through the process and they may have figured that they would make so much money running the business that they would pay off the tax debt in short order. They did not stop, look and listen. If the seller ran up a $440,000 sales tax debt, how were they going to make so much money that they would avoid the pitfall?

Accordingly, the OTA had no mercy and held the Welkers personally responsible. Think about it. They put a huge amount of money down, gave back the business to the seller to settle litigation, and still ended up personally liable to the extent of every dollar paid to the seller. In other words, they lost it all and then some.

Is Smoochie LLC Responsible for Paying the Back Taxes

The Welker’s primary defense and argument before the OTA was that Smoochie LLC was the real debtor and not them personally. Therefore, only Smoochie should be responsible. If that were the case, the Welkers could wind up closing down Smoochie and walking away from the unpaid tax debt. The argument did not work. The OTA pointed out that Smoochie was formed after the close of escrow. When escrow closed the business passed first to the Welkers, and thereafter to Smoochie. The sale was completed before Smoochie came into existence. Timing was everything and the Welkers timely was off. They made one blunder after the next.

EDD Ramifications of Welker

The EDD has similar operative statutes as its sales tax counterpart. CUIC §§1731 – 1733 also provide for successor liability in the event one purchases a business or stock of goods. It is vital to obtain a Tax Clearance Certificate or equivalent from the EDD prior to the close of escrow. CUIC § 1731 states in substance that if the buyer or seller does not produce such a certificate, the acquiring person shall pay the amount or the value of the property. CUIC § 1733 provides for personal liability up to but not exceeding the purchase price.

Conclusion

The Welker case is a great example of how to do everything wrong. It is vital to obtain either a Tax Clearance Certificate or a Certificate of No Taxes Due before one takes possession of sale of a business or stock of goods. The Welkers wound up deeply in debt with nothing to show for it. They cannot blame anyone but themselves. The Welker case is an example of impatience and the failure to listen and obtain competent professional representation. All of these elements make up a clown car driven off a cliff.

***

Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.

Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

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