Tax Considerations When Buying or Selling a Business in Maryland

When structuring the purchase or sale of a business in Maryland, one of the most important tax considerations is a choice between structuring the transaction as a stock sale or an asset sale.  This decision has been covered at greater length in another article that I recently authored, but in very brief summary:  A stock sale is typically the structure preferred by sellers, since a seller typically pays the capital gains tax rate on a stock sale, and the buyer retains the existing tax basis in assets.  An asset sale is generally preferred by buyers, as asset sales provide a step-up in basis for depreciation purposes.  This article will review other tax issues, beyond the “stock sale v. asset sale” question.

Bulk Sales Tax

Maryland applies a 6% tax to tangible personal property that is included in a business sale.  The Bulk Sales Tax applies to furniture and fixtures, computer software, business records, customer lists, and non-capitalized goods and supplies.  There are exemptions from application of the Maryland Bulk Sales Tax, including the following:

The “Resale Inventory Exemption” exempts from Bulk Sales tax tangible personal property that was purchased for purposes of resale.  To benefit from this exemption, a seller must have maintained documentation demonstrating that the subject inventory was held exclusively for resale.  The seller also must obtain a resale certificate from the purchaser.

The “Manufacturing Equipment Exemption” exempts from Bulk Sales tax manufacturing equipment and machinery that is used directly in the production process, and that passes a “used directly” test that is established under Maryland state tax regulations.

The “Motor Vehicle and Transportation Equipment Exemption” exempts sales of vehicles and transportation equipment that are required by the State of Maryland to be titled and registered.  These are instead subject to excise taxation under the Maryland Transportation Code.

Some types of “Occasional Sales” also are exempt from Bulk Sales taxation, if they are casual and isolated sales that the company does not regularly engage in as part of the business.  These must be one-time or isolated transactions that are undertaken no more than three times in any twelve-month period.

The “Affiliated Entity Transfer Exemption” may except from Bulk Sales taxation certain transfers that are between two entities that have common ownership at a level of 80% or greater, as long as the common ownership continues for at least two years after the transfer.

To support any or all of the above exemptions from Bulk Sales taxation, the company must maintain contemporaneous documentation supporting the exemption(s), such as copies of written agreements specifying the exempt assets, as well as resale or exemption certificates where applicable. Failure to properly document exemptions can result in assessment of the tax, with interest and penalties, along with personal liability for responsible parties.

Sales and Use Tax

Maryland has a Sales and Use Tax that may apply to transfers of tangible personal property in the sale of a business. Maryland law provides several potential exemptions from these taxes, which may apply when there is a sale of an entire business.

The sale of an entire business or of a complete business division may qualify for exemption if the sale encompass all or substantially all of the business assets, the assets are sold as a going concern, and the purchaser continues the same type of business operation following the transaction.  The following asset classes remain subject to sales and use taxation, however, even if the transaction as a whole is exempt: (1) inventory not held for resale, (2) office equipment and supplies, (3) non-production equipment, and (4) consumable supplies.

The statute also provides an exemption for casual and isolated sales, which may apply to the sale of an entire business when the transaction is properly structured. To benefit from this exemption, the sale transaction may not be of a type that is regularly engaged in by the seller, and it must be infrequent and not part of a series of sales.  The seller must not be regularly engaged in the business of selling similar items. No more than three sales may occur within a twelve-month period, and the exemption applies only to sellers not otherwise required to hold a Maryland sales tax license.

Maryland law also provides an exemption for some statutory mergers, consolidations, and other types of qualifying corporate reorganizations.  To qualify under this exception, the transaction must qualify as a tax-free reorganization under IRC § 368, must be between qualifying business entities, and proper documentation of the reorganization must be maintained.

Real Property Transfer and Recordation Taxes

If the sale or purchase of a Maryland business includes the transfer of real property, then a county or local Transfer and Recordation Tax will apply, based on the amount of consideration paid for the real property in the transaction.  Maryland appellate courts have recently made clear that Transfer and Recordation Taxes are not to be based upon the value of any intangible business assets transferred in the transaction, or on Goodwill, or on the value of transferred business licenses.  This makes proper allocation of the purchase price between real and intangible property an important part of any purchase and sale agreement, where real property is a component of the transaction.

Summary

Careful tax planning in Maryland business sales transaction can yield significant savings for both parties. During the due diligence process prior to consummation of a business sale, it is important for the due diligence team to review past tax returns and filings, to ensure compliance with bulk sales requirements, and to assess any transfer tax obligations.  It is good practice to model the tax impact of different deal structuring options, and to consider both parties’ tax objectives during negotiations.  It’s also important to comply with bulk sales notice and payment requirements, where applicable to a particular transaction. The optimal structure and transaction terms depend on specific circumstances of a particular transaction, and may require balancing competing tax objectives.

None of the information provided in this article constitutes legal advice or tax advice.  Every situation is different and should be thoroughly reviewed by and discussed with your legal and tax advisors. Please do not rely on the contents of this article as the basis for making decisions regarding your particular situation.  If you are contemplating the purchase or sale of a business in the State of Maryland, Lewicky, O’Connor, Hunt & Meiser stands ready to provide legal support for your contemplated transaction.