You're Not Just Buying the Business. You're Buying Its Tax Problems.

I'm working on a deal right now where the target company has been paying a contractor close to $150,000 a year. Single job. No other employer. Gets a 1099 at year end.

That's not a contractor. That's an employee who hasn't been classified correctly. And whoever buys this business is walking into that problem unless we deal with it now.

This comes up in nearly every transaction I touch. And it's exactly the kind of issue buyers miss when they treat tax due diligence as an afterthought.

Most buyers think of diligence as a checklist: review the financials, confirm the revenue, check the customer list. But tax diligence isn't about auditing the past. It's about understanding what obligations you're actually inheriting, and making sure you're not the one who ends up paying for someone else's mistakes.

Successor Liability: The Risk That Follows the Business

When you acquire a business, you don't always acquire its liabilities. That's one of the reasons asset acquisitions are so common in SMB deals. But successor liability doesn't disappear just because you structured the deal as an asset purchase.

Depending on the jurisdiction and the nature of the liability, you can still be on the hook for unpaid payroll taxes, sales taxes, and certain employment-related obligations, even if they accrued before you existed as a company. The IRS has long reach. State tax authorities, in some cases, have longer ones.

This is why deal structure matters, but it doesn't substitute for understanding what liabilities exist in the first place. You need to know what's there before you can protect yourself from it.

The 1099 Trap

Employee misclassification is one of the most common issues I see in small business diligence. It's also one of the most consistently underpriced risks in deal negotiations.

Here's what it looks like in practice. A business has been paying someone $150,000 a year as an independent contractor. That person has no other clients, no other income, and works exclusively for this company. Under the IRS's control tests and most state equivalents, that's almost certainly an employee, not a contractor.

The consequences: back payroll taxes, penalties, and interest that can reach back several years. If the seller hasn't addressed it, that exposure doesn't evaporate at closing. It becomes your problem.

The fix isn't complicated, but it requires catching it before the deal closes. That might mean escrowing funds, repricing the deal, requiring the seller to cure it as a condition of closing, or in some cases walking away. What it cannot mean is ignoring it and hoping no one notices.

Timing Is Everything

Here's where most buyers make the real mistake. They treat tax diligence as something that happens after the purchase agreement is drafted. Sometimes after the LOI is signed. Sometimes when the deal is basically done.

That's backwards.

When you find a problem during diligence, before the purchase agreement is negotiated, you have options. You can reprice. You can build in representations and warranties. You can require the seller to resolve the issue as a condition of closing. You have leverage.

When you find a problem after the purchase agreement is signed, you have a dispute. The seller's position hardens. Your recourse is limited to whatever the contract says, which may not be much if you didn't know to ask for it in the first place.

Tax diligence should start early. It should inform your LOI. It should shape your reps and warranties. It should be part of how you price the deal.

The Real Takeaway

When you buy a business, you're not just buying its revenue and its customers. You're buying its history: its classification decisions, its tax positions, its exposure.

The question isn't whether there are problems. There almost always are. The question is whether you find them in time to do something about it.

Don't sleep on tax due diligence. And don't wait until after the purchase agreement is drafted to start.

Until next time,

Josh