I’m working on my first bulk sale escrow. What tax clearance certificates are necessary and are they simple to apply for?
Tax Clearance Certificates are an unavoidable requirement of the bulk sale process in California.
EDD (Payroll taxes), FTB (income taxes), CDTFA (sales tax) and County (Business property taxes) require notification of any business sale. This is a “net” for these agencies to catch sellers on the way out of a business, ensuring seller’s obligations are satisfied. The purpose of tax clearances are satisfying the requirements of the respective agencies to prevent seller’s liability from rolling over to the buyer. Tax clearances do not mean, necessarily, that the seller is in the clear. It means that the BUYER is cleared of liability.
Each of these agencies have successor liability to the buyer for the seller’s tax liability if the buyer fails to make sure the agencies are satisfied BEFORE the seller is paid.
Unless the seller is currently delinquent, EDD and FTB generally issue releases without a lot of fanfare or hoops for the seller to go through. EDD and FTB are typically more willing to release buyers right away and make note of the fact that the seller has sold the business. Even with a release issued, the seller may still have funds due or additional tax returns to file with these agencies.
The EDD is concerned about mis-categorizing employees as independent contractors, instead of employees. This impacts many industries such as beauty salons, trucking companies, cleaning services, and more. In cases where a seller states “no employees,” EDD may require an audit before they will issue a release. This is the only way for a BUYER to protect themselves against the liability of seller’s taxes.
CDTFA typically has the most requirements. Before issuing the release, CDTFA requires:
- From Escrow: a copy of the Escrow Instructions, Bill of Sale, buyer and seller approved list of Furniture, Fixtures and Equipment (FF&E) and the allocation of the purchase price, including the value of FF&E**
- From the seller: a final sales tax return through their last day of business. This happens AFTER the seller has conducted their last day, generally AFTER close of escrow.
- On the seller’s final sales tax return the sales tax must be paid on the value of the FF&E
- Seller must file a Notice of Closeout
- CDTFA will sometimes choose a seller to conduct a sales tax audit, which can delay the issuance of the release for weeks after closing.
- Buyer must obtain their own resale permit before CDTFA issues a release.
If the CDTFA questions the value of the FF&E, they reach out to escrow and require that the seller give more detail to justify the value.
To recap, EDD, FTB, CDTFA and the County Tax Collector in the location of the business all utilize the bulk sale process to make sure exiting sellers pay their own obligations. You could say that to put “teeth” in their requirements, the agencies will potentially pass successor liability for the seller’s debts to a buyer, if no tax clearances are issued. These State agencies have precedence over the seller and the seller’s other debts, meaning that if there is insufficient funds to pay all of the seller’s debts and obligations, the taxing agency may get paid before others. The Bulk Sale Code and Business and Professions Code specifies the priority for the payment of debts in a cash short closing. This precedence over other debts is why there is a requirement that seller’s funds (which can be up to and including the entire purchase price) are held at the close of escrow.
For more information, visit:
FTB: https://www.ftb.ca.gov/forms/Search/Home/FormRequest/2859 (Note: this is a link, you will need to provide your email address to get a copy of the publication)
Independent Contractor Status: https://edd.ca.gov/siteassets/files/pdf_pub_ctr/de573m.pdf
Notice of Closeout: https://www.cdtfa.ca.gov/formspubs/cdtfa65.pdf