Ask The California Employment Tax And Payroll Tax Attorney – Traps For The Unwary When Purchasing Corporate Stock

By Robert S. Schriebman
2021

Introduction

Every now and then a case crosses my desk that breaks my heart and causes me to scratch my head at the same time.  I wonder how the people involved got into this situation in the first place and why they did not see the hidden traps just waiting for them.  Often, I find that they made choices with consequences that could have been avoided.   This confronted me when I read the sales tax case involving a Mexican restaurant known as Las Playas #10, Inc. dba Del Mar.  Well-intended good people faced economic ruin because they may have failed to consult with a knowledgeable tax advisor before going down the rabbit hole.  This article will discuss the Del Mar case and the traps that the buyers fell into not only when they bought the business but what may happen to them if the business is forced to close. Las Playa #10, Inc., dba Del Mar, OTA Case No. 18073485, April 21, 2021.

Although my primary specialty involves EDD audits and related issues, I saw in Del Mar the same potential exposure for unpaid EDD taxes.

The Del Mar Case

The Del Mar case illustrates the hidden traps when the stock of a corporation is purchased instead of purchasing only selected corporate assets.  The first hidden trap occurs when stock is purchased as it carries with it any and all problems of the corporation including problems that are disclosed and those that are not.  Del Mar was audited by the sales tax people (CDTFA) for the years 2012-2015. It did not provide complete corporate source documents showing taxable sales such as cash register tapes, guest checks, sales journals, ledgers, and financial statements. The CDFTA had to resort to an indirect method of determining taxable sales based upon credit card sales. The CDTFA determined there was over $686,500 in unreported taxable sales generating a $55,000 assessment plus interest.

On December 17, 2014, the ownership of Del Mar was sold for $126,000.  Only the common stock was purchased, no assets.  A stock sale carries with it all corporate woes.  The buyers did not obtain a Tax Clearance Certificate.  That was the second trap for the unwary.

The escrow instructions stated, “Buyer is taking over the daily operation of the business and is assuming any and all debts owed by the corporation.” That was the third trap for the unwary.

The CDTFA gave the $55,000 bill to the new owners.  They argued that they should not be responsible for the tax liabilities arising before their purchase date of December 17, 2014.  In other words, they should be liable only for post-purchase date unreported sales.

The OTA’s Ruling

California imposes a sales tax on retail sales of tangible personal property measured by a retailer’s gross receipts.  A restaurant is considered a retailer.   R&TC § 6501 states a “seller” includes any person engaged in the business of selling tangible personal property.  A “person” includes a corporation, R&TC § 6005.  The new buyers argued that due to a change of ownership on December 17, 2014, they can only be held liable for unreported taxable sales for periods after the purchase date.  The change of ownership in December 2014 should be treated as a purchase and sale of the business.

The OTA held that Del Mar is a person under the law and its liability for unpaid sales tax is its own responsibility.  You cannot relieve corporate liability by changing stock ownership.  A change in shareholders of a corporation is immaterial for sales tax purposes.  Only the stock was sold, the corporate entity was not disturbed.  The entity owes the taxes regardless of who owns the entity.  The same seller’s permit was held both before and after the sale.

Although the OTA judge made no mention of the buyer’s failure to obtain a Tax Clearance Certificate, that failure was also another hidden trap for the unwary.

The OTA also held that if Del Mar had sold its assets to a different corporation or other entity, and the new corporation operated the business using the old seller’s permit, then both entities could be potentially liable for the deficiency.  Here, only the stock was sold not the business.  Even if the assets were purchased there is another hidden trap.  Things depend upon what assets are purchased.  If the CDTFA finds that the assets of a going business are purchased, that could also trigger successor liability.  There are traps for the unwary all over the place!

The buyers argued that the burden of the entire assessment will require them to sell the business, stripping them of their only source of income to raise their family.  The OTA judge coldly responded that cannot be his concern. Even if the business is sold, or dissolved because of the tax debt, the sellers or previous owners may now be personally liable for unpaid corporate taxes.  That is the final hidden trap for the unwary.

Conclusion

This article discussed the many hidden traps for the unwary when corporate stock is purchased instead of selected corporate assets.  While Del Mar was a case involving assessed sales tax these same traps may apply to the purchase of a business that owes the EDD unpaid employment and withholding taxes.

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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 50 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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