Buying into an LLC's Assets and Liabilities

[Joaopeixe]

Jurisdiction

California

Hello, thank you in advance for reading my question, I appreciate the time of anyone who might be able to offer some baseline advice.

I'll try to keep it short and organized and I apologize if I don't have the correct language for some of my questions. I'll do my best.

The situation is this: Myself and one other person have worked for a small LLC for over ten years. Originally, we worked for three partners who held equal ownership of the business. Over the past two years however, one partner has passed away and the another has withdrawn their ownership due to health related issues (age and dementia). So there is currently a single owner of the LLC.

The single remaining owner is now offering to bring myself and the other long term employee on as minority partners, free of charge. They say as a "thank you" for our long term service and for keeping the business afloat and (even improving it) as they dealt with some pretty rough life circumstances. Specifically COVID, the death of their spouse, and the ailing of their long time friend (the two former partners).

The owner has offered us 15% stake each with the opportunity to buy a majority share in the future, as they wish to retire sooner rather than later. The business is profitable, the staff is like a family, we love what we do. It's "free." Those are the positives.

The difficult part is, as I understand it, we are each signing up for 15% of all assets and liabilities without a real clear idea of what those assets and liabilities are. We have viewed tax returns for the two years prior to COVID and the business was reporting about half a million in sales per year. We know generally what it takes to run the business, so we can see the profitability at least.

Unfortunately, the liabilities are a little hazy. Specifically, in 2019 the business was audited for sales tax years 2015/16 and it was determined that it had been significantly underreporting sales tax which has now resulted in a debt to the IRS for around $200,000 that we have yet to begin making payments on. Also there are some PPP loans (ideally forgiven) and a SBA disaster relief loan for over 100,000$ also hanging out there waiting to be be settled. So... it's a little tough to know what we're exposing ourselves to, and I don't really know the process to finding out.

Some basic questions:

If the LLC is in debt to the IRS for under-reported sales tax and we sign our names into the LLC, do we own that debt? Even though it was incurred before we were part owners?

Could the IRS come back and audit another prior year and would we, as new partners, be be liable for any debt from those back years as well?

If we do own prior tax debt incurred through previous underreporting, does the LLC structure protect our personal assets from the IRS? Let's say worst case scenario... COVID tanks the economy and the business shuts down entirely and the majority owner just goes AWOL, can the IRS come after the us as LLC owners for that unreported sales tax debt?

I know LLCs are supposed to offer protection... but then there's the whole piercing the corporate veil stuff... and it doesn't seem logical that the IRS would accept a bankruptcy claim and write off the debt?

Just to be clear, there was no criminal charges in the sales tax audit and the partner who under-reported sales to the IRS is no longer with the company, having passed away in 2020. (Though they were the spouse of the sole remaining owner.) I don't think the current owner is trying to screw us at all, I just think we are stepping into a situation that was very financially unorganized for many years.

Finally, if we become minority owners and the business ends up paying some or all of that tax debt from before we came aboard through future income, should that amount be taken into account if we decide to buy a larger percentage later?

If we pay a 200,000$ debt on sales tax from revenue that we had no access to, that seems like income for the person who did have access to that revenue. Basically, they made all the money in 2015/2016, we're paying the taxes, right?

It's a really tangled up situation, I know. I understand if it's too messy to offer any real advice, but I appreciate anyone who might be able to just tell me what to look for, how to protect myself, and maybe just a starting point in this whole process.

 

[army judge]

You need to retain your own attorney to advise, guide, and counsel you.

Don't make your problems bigger by failing to do today what you failed to do originally, hire an attorney ASAP.

If you don't, prepare to be fleeced AGAIN!

 

[Zigner]

Specifically, in 2019 the business was audited for sales tax years 2015/16 and it was determined that it had been significantly underreporting sales tax which has now resulted in a debt to the IRS for around $200,000 that we have yet to begin making payments on.

This statement alone is enough to make me vehemently agree with @army judge.

The IRS doesn't collect sales tax.

 

[Joaopeixe]

You need to retain your own attorney to advise, guide, and counsel you.

Don't make your problems bigger by failing to do today what you failed to do originally, hire an attorney ASAP.

If you don't, prepare to be fleeced AGAIN!

Thank you for the quick reply!

Just to be clear, I haven't been fleeced (that I know of...)

I am not in any debt and have contributed nothing but time and energy to this company, for which I have been compensated fairly. Sorry if I over-explained and made it confusing. At the moment, I am just a long time employee with the "opportunity" to become a part owner. Evaluating the risks of the "opportunity" is what I'm trying to get a handle on.

I do agree that I need a lawyer... but do I just call one and lay out what I just said?

 

[Joaopeixe]

This statement alone is enough to make me vehemently agree with @army judge.

The IRS doesn't collect sales tax.

Thank you!

This is more likely a product of my own lack of business experience and language. I said the IRS, but the state audited the business. Maybe the BOE? I just used the IRS as a stand in for government revenue collectors. Sorry to be unclear.

 

[army judge]

The single remaining owner is now offering to bring myself and the other long term employee on as minority partners, free of charge. They say as a "thank you" for our long term service and for keeping the business afloat and (even improving it) as they dealt with some pretty rough life circumstances. Specifically COVID, the death of their spouse, and the ailing of their long time friend (the two former partners).

Hmmm, the above commentary explains the commentary below!!!

Unfortunately, the liabilities are a little hazy. Specifically, in 2019 the business was audited for sales tax years 2015/16 and it was determined that it had been significantly underreporting sales tax which has now resulted in a debt to the IRS for around $200,000 that we have yet to begin making payments on. Also there are some PPP loans (ideally forgiven) and a SBA disaster relief loan for over 100,000$ also hanging out there waiting to be be settled. So... it's a little tough to know what we're exposing ourselves to, and I don't really know the process to finding out.

Frankly, upon further reflection, you could save yourselves some money by simply saying, "How thoughtful of you to offer me 15% of your business. Regrettably, I must decline."

You simply have no idea just how much debt is owed to which government agencies. Even if you knew it to $5,000,000, that's reason enough for anyone with a brain to politely decline what appears to resemble a Trojan Horse.

 

[adjusterjack]

Unfortunately, the liabilities are a little hazy. Specifically, in 2019 the business was audited for sales tax years 2015/16 and it was determined that it had been significantly underreporting sales tax which has now resulted in a debt to the IRS for around $200,000 that we have yet to begin making payments on. Also there are some PPP loans (ideally forgiven) and a SBA disaster relief loan for over 100,000$ also hanging out there waiting to be be settled. So... it's a little tough to know what we're exposing ourselves to, and I don't really know the process to finding out.

You will each be buying 15% of those debts.

If the LLC is in debt to the IRS for under-reported sales tax and we sign our names into the LLC, do we own that debt?

Not personally. Indirectly, maybe, as your pay and your profits might evaporate as a result of the debt. And if the company's bottom line becomes a negative you may have to contribute your own money to shore up the company.

It's a really tangled up situation, I know.

A damned good reason to say "no" to the offer.

I am just a long time employee with the "opportunity" to become a part owner. Evaluating the risks of the "opportunity" is what I'm trying to get a handle on.

Big risks. You don't step in the bear trap on the odd chance that it won't tear your foot off.

I do agree that I need a lawyer.

Since you are only an employee, you don't need a lawyer to just say "no."

my own lack of business experience

There's another reason to say "no."

Seems to me that the current owner wants to eventually bug out and leave others holding the bag.

Personally, I'd give it a hard pass.

 

[Joaopeixe]

Hmmm, the above commentary explains the commentary below!!!




Frankly, upon further reflection, you could save yourselves some money by simply saying, "How thoughtful of you to offer me 15% of your business. Regrettably, I must decline."

You simply have no idea just how much debt is owed to which government agencies. Even if you knew it to $5,000,000, that's reason enough for anyone with a brain to politely decline what appears to resemble a Trojan Horse.

Right, thank you!

I guess that's what I'm getting at. Is there a way to obtain an LLCs total liabilities? It seems like there would be, since that would have to be taken into account in any sale... is it a public record that can be accessed or would an accountant or lawyer perform that sort of service for me?

I know these are famous last words, but this person is not trying hit me with a trojan horse. Our families are interconnected, it's not malicious. BUT that doesn't mean it won't unintentionally cost me the just the same because it has been very disorganized for many years under a previous partners management.

I also know that as a legal professional you can't really count on "they're not trying to fleece me" as a reliable statement, so I appreciate your suggestion towards "thanks but no thanks."

 

[Joaopeixe]

You will each be buying 15% of those debts.



Not personally. Indirectly, maybe, as your pay and your profits might evaporate as a result of the debt. And if the company's bottom line becomes a negative you may have to contribute your own money to shore up the company.



A damned good reason to say "no" to the offer.



Big risks. You don't step in the bear trap on the odd chance that it won't tear your foot off.



Since you are only an employee, you don't need a lawyer to just say "no."



There's another reason to say "no."

Seems to me that the current owner wants to eventually bug out and leave others holding the bag.

Personally, I'd give it a hard pass.

Seems like that's the consensus, thank you!

Obviously I'd only need a lawyer if I wanted to continue investigating the option to become a part owner... obviously not if I just declined outright. I realize that much at least.

 

[adjusterjack]

I guess that's what I'm getting at. Is there a way to obtain an LLCs total liabilities? It seems like there would be, since that would have to be taken into account in any sale

You can hire a forensic accountant to do a full audit of the business, past and present. Considering the irregularities (putting it nicely) of the past, there is a good chance that irregularities will be found in the present.

I know these are famous last words, but this person is not trying hit me with a trojan horse. Our families are interconnected,

There's a third reason to say "no." Doing business with family is a good way to get fleeced. We see that all the time. Whether the fleecing is intentional or unintentional it's still a fleecing.

Family, debt, tax shenanigans. Three strikes. Yer out.

 

[Tax Counsel]

Some basic questions:

If the LLC is in debt to the IRS for under-reported sales tax and we sign our names into the LLC, do we own that debt? Even though it was incurred before we were part owners?

In general, no, you have no personal liability for the debts of the LLC prior to when you become members of it.

Could the IRS come back and audit another prior year and would we, as new partners, be be liable for any debt from those back years as well?

No. The only income you are responsible for is the income that was earned during the time you are a member of the LLC. It would be whoever was a member of the LLC for the years under audit that would have to worry about.

If we do own prior tax debt incurred through previous underreporting, does the LLC structure protect our personal assets from the IRS?

Again you are not liable for tax on income of the LLC prior to you becoming a member of the LLC. But while you are a member of the LLC, the income of the LLC flows through to the members and ends up on their personal income tax returns because LLCs with more than one member are taxed as partnerships unless the LLC elected to be taxed as a corporation.

can the IRS come after the us as LLC owners for that unreported sales tax debt?

The state rules for sales tax varies from state to state. Generally, though, even if members might be personally liable for sales tax not paid to the state, again that would typically only be for sales taxes that were (or should have been) collected while you were a member. Sales tax that should have been collected or that were collected and not paid prior to when you join as a member wouldn't generally be your obligation to pay personally.

I know LLCs are supposed to offer protection... but then there's the whole piercing the corporate veil stuff... and it doesn't seem logical that the IRS would accept a bankruptcy claim and write off the debt?

It's not up to the tax agency what debts are discharged in bankruptcy and which are not. That's determined by the bankruptcy code. Some taxes are indeed eligible for discharge in bankruptcy, but the rules for that are too complex for a message board forum to dive into. I will tell you that of all the debts of a business, paying withheld employment taxes and collected sales taxes are among the most important. Those you won't get discharged in bankruptcy and tax agencies are the most aggressive in collecting those taxes compared to other tax liabilities.

You really want to consult both a business attorney and tax attorney for advice and assistance with reviewing the details of this offer before you agree to take a share of the LLC. There are potential risks in any business arrangement and you want to minimize those as much as possible.

 

[army judge]

A corporate or business entity that collects sales taxes, payroll taxes, or any other mandated collection by a governmental agency has no excuse NOT to ensure ALL monies collected is immediately forwarded to the appropriate taxing authority.

If one dollar of that money (usually its thousands, if not hundreds of thousands of dollars) isn't forwarded to the various taxing authorities within 24 hours of it's collection, something foul, illicit, and devilish is afoot.

Usually the owner (could be a partner, or high ranking employee, although low ranking employees skim, too) is stealing the tax money to cover personal expenses, or other unpaid debts.

The fact that the business in question didn't disburse/remit the taxes it collected in a timely manner is enough for a prudent person to say, if offered a share of the business, "Sorry, I thank you for offering me a share of your business, but I'm happy simply being in the employ of a wonderful boss, YOU!"

 

[Zigner]

If one dollar of that money (usually its thousands, if not hundreds of thousands of dollars) isn't forwarded to the various taxing authorities within 24 hours of it's collection, something foul, illicit, and devilish is afoot.

That's not how collection and remittance of sales tax, payroll tax, and I'm sure most (if not all) other taxes works in CA.

 

[army judge]

That's not how collection and remittance of sales tax, payroll tax, and I'm sure most (if not all) other taxes works in CA.

I don't think it is any different in California than any other State or territory.

The point I'm making is IF the business collected the money, why wasn't it remitted, even if had to be held for three months?

Usually if it isn't remitted, it gets spent for other expenses, or its stolen by someone.

We place all such mandated collectibles in an escrow account, where its held by our bank until it is time to remit it to the taxing authorities.

That's how we do it on my cattle ranch and my law firm.

In fact, that is also how my wife and I do it for our personal finances.
The difference there is it is held in escrow for a year, until we file our federal taxes.

 

[Tax Counsel]

The point I'm making is IF the business collected the money, why wasn't it remitted, even if had to be held for three months?

Usually if it isn't remitted, it gets spent for other expenses, or its stolen by someone.

For any collected tax (meaning a tax that the business collects in trust for the government, like sales tax collected from customers or employment taxes deducted from an employee's pay check) I agree with you that the failure to remit them to the government timely (whatever the time deadline is) is a big red flag of either a failing business or malfeasance. The temptation of struggling businesses is to "borrow" these funds from the government to pay the creditors who are right then pounding on their doors. While that may keep the business open a little longer, it's ultimately a mistake. The penalties the business incurs by failing to pay the taxes puts the business in an even deeper hole, and it becomes a cycle that dooms the business to failure. One of the most important lessons I learned as a finance student in college is that you not only need to understand when to start a business, but also when it's time to get out. Too many entrepreneurs stay in way too long; much past the time when it should have been clear that it wasn't going to work.

 

[Zigner]

I don't think it is any different in California than any other State or territory.

The point I'm making is IF the business collected the money, why wasn't it remitted, even if had to be held for three months?

Usually if it isn't remitted, it gets spent for other expenses, or its stolen by someone.

We place all such mandated collectibles in an escrow account, where its held by our bank until it is time to remit it to the taxing authorities.

That's how we do it on my cattle ranch and my law firm.

In fact, that is also how my wife and I do it for our personal finances.
The difference there is it is held in escrow for a year, until we file our federal taxes.

I totally agree that taxes should be remitted in a timely manner. I was just pointing out that "within 24 hours" is not the requirement for most taxes. I won't say "all" because it's possible that there is a requirement to remit some tax within 24 hours of collection that I'm not aware of.

 

[army judge]

I totally agree that taxes should be remitted in a timely manner. I was just pointing out that "within 24 hours" is not the requirement for most taxes. I won't say "all" because it's possible that there is a requirement to remit some tax within 24 hours of collection that I'm not aware of.

If your business doesn't have good financial controls, fails to pay debt in a timely manner, those taxes must be protected.

You either stash tax revenues away to be paid promptly, or you pay them as you collect them.

I doubt that the taxing authority would care if you paid more than you owe.

My wife and I always pay more than we owe to avoid any later discrepancy or error.

Here is how Texas allows a business to remit sales taxes.

In Texas, you will be required to file and remit sales tax either monthly, quarterly, or annually.

Texas sales tax returns are always due the 20th of the month following the reporting period.

If the filing due date falls on a weekend or holiday, sales tax is generally due the next business day.

There is NEVER any reason NOT to remit what you've collected from your customers in a manner consistent with the laws of the tax authorities.

 

[adjusterjack]

I was just pointing out that "within 24 hours" is not the requirement for most taxes.

Right. There may be exceptions but sales taxes are often required to be reported and remitted monthly.

 

[Zigner]

Right. There may be exceptions but sales taxes are often required to be reported and remitted monthly.

Quarterly or monthly, depending on the volume of sales.

 

[Tax Counsel]

There is NEVER any reason NOT to remit what you've collected from your customers in a manner consistent with the laws of the tax authorities.

I wouldn't go quite that far. There are circumstances that arise that, despite one's best efforts, prevent one from getting a return filed or a tax paid on time. When I was an officer for the IRS I once abated penalties for a taxpayer who, on the day tax deposits were due at the bank (which is how employment tax deposits were paid) was gored by one of his steers and landed in the hospital. He took care of paying over the deposit once out of the hospital. I judged that a pretty good reason for the late deposit.