This article provides an introduction to the legal nitty-gritty of buying an established business.
A business is simply a collection of assets. Someone who offers a business for sale is trying to sell all these assets together, from the IRS's point of view. A buyer may not want all of a business's assets. You want to buy Sal's Pizza Parlor for its location, but you don't want Sal's business name or the old pizza ovens and furniture. If you make Sal a good enough offer, he may sell just the building to you and not the rest of the assets. However, the tax consequences of this type of sale may be different than if you had purchased all of the assets. How the business is legally structured - sole proprietorship, partnership, limited liability company or corporation - also has important tax consequences to both the buyer and seller.
If you buy a partnership, limited liability company or sole proprietorship, you are getting just its assets - a store lease, inventory, customer list and so on. Normally, you don't take over business-related liabilities, including tax debts. Your contract should require the seller to pay all debts before closing or out of escrow. If not, then the debts remain the seller's personal responsibility after the transfer.
The IRS never releases the seller from unpaid taxes when a business is transferred. But you normally don't have to worry about the seller's tax debts unless the IRS or state taxing agency has filed a tax lien against the business or the owner.
Example: Angelo, a sole proprietor, sells his profitable business, Korner Mart, to Luigi. Angelo has not filed or paid income taxes for the past three years. The IRS hasn't caught on to Angelo - yet. Luigi takes the business assets free of any tax liability of Angelo, who remains personally liable for taxes he should have paid on the business income before the sale.
You are not required to notify the IRS prior to purchasing or selling a business.
The tax situation is more complex when you buy an incorporated business. Whether you buy corporate shares or its assets instead is a crucial choice, because:
If you buy only a corporation's assets, you don't assume its liabilities, including taxes.
If you buy a corporation's shares of stock, however, you end up with both its assets and liabilities - including known and unknown taxes. An example of an unknown tax debt would be one that resulted from an IRS audit that has not yet begun. The seller of the corporate shares is released from all corporate debts unless he personally guarantees them or agrees to be liable for them after the transfer.
Why should you ever consider buying a corporation's stock, given the potential for legal trouble? Because some owners will sell only if a buyer takes corporation stock. There are several reasons why a seller may insist. One, as mentioned, is to rid himself of any potential tax liabilities, since the buyer assumes these along with the stock. But even a perfectly honest seller may have a tax reason for selling stock instead of assets.