Wow, October is almost gone! One of my favorite but perhaps most frustrating chores this month is raking the leaves. There are several huge Pin Oaks around my home that provide great shade in the summer and a blanket of leaves in the fall. I always rake the leaves into one or two huge piles for the children on my block who love to jump into the leaf piles. I always make sure that no branches or hard objects in my “merger” of leaves end up in the inviting pile of orange and gold.
The same can be said about raking up dangerous state and local tax objects during a seemingly innocuous merger or liquidation of related entities.
This will be the final post in our Fall Clean Up series. We will identify and briefly discuss some of those potentially significant dangerous state and local tax “hard objects” that may be hidden in the leaves of a seemingly“innocuous” merger or liquidation of related entities.
Successor State Tax Liability Considerations
As we pointed out in our April 2014 post Could You Be Liable Under NY’s Recent “Bulk Sale”
Guidance – Even if You’re Not a Buyer? even transactions that are “tax-free” for multistate income, sales and use tax purposes may create a bulk sale filing responsibility as well as create “Successor Liability,” i.e. create potential transfer of liability of one entity to another entity.
Consider if Company A, which has significant sales and use tax issues in open tax years, is merged into or liquidated into Company B, another commonly owned entity. The affected states in which Company A had legacy sales and use tax issues may now pursue satisfying their claims arising from Company A’s activities against Company B’s assets. Of course the opposite may be true as well with respect to Company B’s legacy sales and use tax issues.
Therefore, each affected state’s bulk sale filing and successor liability provisions should be considered prior to merging, liquidating or transferring operations among commonly owned and controlled legal entities. It should be noted that “successor liability” tax provisions, though historically primarily applicable to sales and use tax liabilities, are now being expanded to include other state taxes including gross receipt, net income and employer payroll taxes.
State Employment Tax Ramifications
State employment tax compliance and employer tax rate considerations are highly entity specific and sensitive. Merging or liquidating an entity may result in loss of that entity’s favorable employment tax attributes – i.e. the entity’s legacy unemployment experience rate. Equally disconcerting, merging or liquidating an entity with less favorable employment tax attributes into a new or existing entity with more favorable employment tax attributes may be considered “SUTA Dumping” – State Unemployment Tax dumping. See the SUTA Dumping Prevention Act of 2004 that President Bush signed into law in 2004.
In its May 2014 Industry Insights issue, Tax Intelligence: State Initiatives to Detect SUTA Dumping, Equifax provides an excellent summary and starting point in understanding the potential breadth and seriousness of this issue. As indicated in the discussion, “The Act was intended to prohibit certain perceived abuses of the state unemployment insurance (“SUI”) system….” The bulletin further states that “The Act continues to have significant implications to employers undertaking merger or acquisition (M+A) transactions.…”
It is critical that complete analysis of the potential SUTA ramifications be thoroughly vetted with a SUTA expert before any entities that historically, presently or prospectively have employees are merged or liquidated.
State Tax Credit and Incentive “Claw-Back” and Transferability Considerations
As noted, state and local tax credits and incentives are highly entity specific. Such tax credits and incentives are often based on both historic as well as future activities of the entity that seeks the credit or incentive. Merging or liquidating an entity that has qualified for a state tax credit or incentive may have significant ramifications on both the historic credit taken as well as the ability to continue to take the credit in the future.
First, many state and local tax credits or incentives may have “claw back” provisions. These provisions may require an entity that has received the benefit or a credit or incentive to pay back prior credits or incentives received if that entity does not continue to meet the credit’s or incentive’s threshold criteria. Such threshold criteria are required to be maintained throughout a period set forth by the state or locality that may extend for a significant time beyond the initial year of the credit or incentive. Merging or liquidating the entity into another related entity may inadvertently and retroactively disqualify the entity that received the credit or incentive.
Equally important, the “credit” or “incentive” may be entity specific – i.e. not transferrable to another entity, even a related or successor entity. Merging or liquidating an entity that has taken or will be eligible for state and local tax credits or incentives may result in a “claw back” as well as loss of future benefits of the credit or incentive by the successor entity.
A comprehensive review of the potential state tax credit ramifications arising from the merger or liquidation of an entity that has or is taking state tax credits or received state or local incentives should be completed before commencing any merger or liquidation of such entity.
State Tax Exams, Appeals and Collection Implications
A careful review of an entity’s current, as well as past, state tax exam status should be completed prior to the merger or liquidation of the entity. Equally important, such an entity’s state tax exam status should be completed prior to transferring a related entity’s assets to the entity, merging or liquidating a related entity into the entity in question.
There are numerous, potentially costly, state tax ramifications that may arise from not adequately vetting an entity’s state tax exam status. The following are some of the state and local tax exam considerations that you should fully vet before commencing the merger or liquidation of an entity under state tax exam:
- State Tax Clearance Concerns: If an entity is under state tax exam, that state may not give tax clearance to the entity prior to the close of the current exam.
- Expansion of Years under Exam: Upon providing the often requisite notification to a state that an entity may be liquidating, if the entity is already under state tax exam by that state, the state may extend the period under exam through to the current tax year.
- Acceleration of State Tax Exam Assessment: Additionally, upon notifying the State that the entity it is auditing is being merged or liquidated, the State may accelerate its determination of the assessment, thereby limiting the opportunities for submission of additional documentation or informal negotiations.
- Negative Affect or Procedural Issues on State Tax Appeals: The precise status of each state exam and appeal of a state tax assessment should be known and reviewed prior to merging or liquidation of the entity. The state tax appellate procedures, especially notification or representation, should be carefully reviewed before the entity is merged or liquidated.
Finally, keeping in mind the Successor Liability concerns indicated above, merging or liquidating a related entity into an entity already under state tax exam may significantly increase the assets that the state may attach or pursue in settling a potential assessment against that surviving entity.
Trick or Treat – Don’t Let the Merger or Liquidation of an Entity Result in State Tax BOOs!
Well, it’s almost Halloween. Each year, my wife and I, in an attempt to avoid leftovers, seek to purchase just the correct amount and mix of “treats” to dispense to our assortment of funny, cute and imaginative Halloween visitors. This year I even sought out more expert advice and checked the CDC’s Halloween Health and Safety Tips and the FDA’s Halloween Food Safety Tips for Parents. Hopefully our Fall Clean Up series has been helpful in assisting those of you who are considering merging or liquidating related entities from experiencing state tax tricks instead of reaping state tax treats from your reorganization endeavors. Have a Happy Halloween!