Who this is for
- Buyers of a US small business whose seller's profit and loss, tax returns and bank deposits disagree
- Buyers of a sole proprietorship, partnership or corporation, whether the deal is for assets or ownership interests
Not covered here
- Whether to buy assets or the company, price allocation and old tax debts
- Whether you need a quality of earnings report, and what one costs
- Valuing the business or negotiating its price
- A seller preparing books for a buyer's review
The seller's financials don't match the tax returns: which number can I rely on?
To verify a small business's financials before you buy, rely on the figure that traces to records the seller does not control: bank deposits and card-processor reports. Tax and payroll filings, checked against the IRS's copy, show what the seller reported, not whether it was complete. The seller's profit and loss statement is a claim until those records support it.
| Record | What it can show | What it cannot show |
|---|---|---|
| Seller's profit and loss statement | What the seller says the business earned | Anything on its own, because the seller wrote it |
| Filed return and IRS transcript | What was reported to the IRS, and that a return was filed | That every sale was reported; a return transcript omits attached statements and later changes (IRS) |
| Bank statements | Money that actually arrived | Cash never deposited; the total also holds transfers, loans and owner deposits |
| Card-processor reports and Form 1099-K | Card and app payments | Cash; a 1099-K can miss receipts and include sales tax (Publication 334) |
| Sales tax and payroll filings | What the seller told the state and the IRS about sales and wages | Whether those sales were complete |
Two correct profit figures can differ. The accounting method, depreciation and documented owner costs explain some gaps (see below). Sales that reached neither the bank nor the return can be tested only against other records, such as register tapes, supplier invoices and sales tax returns; without them, a price built on those sales rests on the seller's word alone.
A case is not simple when cash is not deposited, the seller will not release records or sign for the IRS to share them, a return was never filed, sales cross state lines, the records are in another language or accounts outside the US, the seller is a partnership or corporation whose owners also use their own accounts, or the offer is accepted and the seller explains a gap without records. Gather the documents in the next section before you discuss price again; if the offer is accepted, read the last section first.
Which documents should I ask the seller for when buying a small business?
Due diligence starts with the records that produced each figure, for the same periods, covering at least the last three tax years and the current year to date. The IRS names the documents that support gross receipts: cash register tapes, bank deposit slips, receipt books, invoices, credit card charge slips and Forms 1099 (Publication 583).
| Ask for | What it tests |
|---|---|
| Filed federal and state income tax returns with every schedule, including K-1s for a partnership or S corporation | The profit and sales the seller reported |
| Year-end and monthly profit and loss statements, balance sheets and the general ledger | How the seller's figures were built |
| Statements for every business bank account, and for any personal account that received business money | What actually came in and went out |
| Card-processor monthly reports, Forms 1099-K, and register or point-of-sale daily sales reports | Card and cash sales |
| State sales tax returns | Sales reported to the state |
| Payroll returns (Forms 941 and 940), wage statements and deposit records | Wages, and whether payroll taxes were paid |
| Year-end inventory and count sheets | Stock on hand and cost of goods sold |
| Asset list, depreciation schedule and vehicle titles | Equipment the business owns |
| Loan statements, repayment schedules, leases and any IRS or state notices | What the business owes |
Prefer statements downloaded from the bank or processor over retyped spreadsheets.
How do I tie bank deposits and card-processor reports to the seller's reported sales?
Total the deposits month by month, remove everything that is not a sale, then compare the result with sales on the profit and loss statement, the return and the sales tax returns. IRS examiners run a similar bank deposit analysis, removing nontaxable deposits and adding receipts never deposited (Internal Revenue Manual 4.10.4).
- List every deposit for each month in every business account and in any personal account that received business money.
- Remove transfers between the seller's accounts, loan proceeds and money the owner put in, because none of them is a sale. Borrowed money is not income (Publication 334).
- Remove sales tax collected for the state when the tax is imposed on the buyer, since it is generally not the seller's income (Publication 334). Compare it with the sales tax returns instead. If the state imposes it on the seller, the amount collected is part of gross receipts (Publication 334).
- Card payouts arrive after the processor takes its fees and refunds. Using its monthly report, add the fees back to get card sales net of refunds, and the refunds too to get gross card sales. Compare gross with gross receipts and net with net receipts; net receipts are gross receipts minus returns and allowances (Publication 334).
- Add cash spent or kept before it reached the bank, only where a register tape or daily sales summary supports it.
- Allow for timing. A payout lands days after the sale, and on accrual books an unpaid invoice is a sale with no deposit yet, so ask for opening and closing receivables: the IRS's own deposit analysis adds an increase in receivables to gross receipts and subtracts a decrease (Internal Revenue Manual 4.10.4).
- Compare each month with the sales the seller reports. List every gap.
A card processor sends the seller a Form 1099-K for card payments of any amount; a payment app or marketplace must send one when payments exceed $20,000 in more than 200 transactions, and may send one for less (IRS). Treat a 1099-K as a cross-check, not the sales figure: it may not include all receipts and may include items, such as sales tax, that are not receipts (Publication 334). To match card payouts to sales line by line, see reconciling sales and payouts.
Can I get the seller's IRS tax transcript to confirm the returns were filed?
Not on your own: the seller has to get the transcript or sign for someone else to see it. A business can get a transcript in its business tax account, by mail with Form 4506-T, or by phone (IRS), and the IRS mails it only to the taxpayer's address of record (Form 4506-T). The seller can then hand it to you, or sign Form 8821 naming your accountant, which lets the designee inspect or receive the tax information listed on the form. Form 8821 does not request copies of returns. For a corporation, generally an officer with authority to bind it can sign; for a partnership, any person who was a member during the period (instructions). A lender financing the purchase can instead request it through the IRS's Income Verification Express Service (IVES), which the seller approves (IRS); see the quality of earnings guide.
| Transcript | What it shows |
|---|---|
| Tax return transcript | Most line items of the return as filed; no attached statements and no changes made after filing |
| Tax account transcript | Payments, penalties and interest, balance due, the filing date, and adjustments made by the seller or the IRS after filing (IRS; Form 4506-T) |
| Record of account | Both of the above in one |
| Employment tax return transcript | Forms 940, 941, 943, 944 and 945, for recent years |
The IRS offers these for businesses at no cost (IRS). A return transcript request on Form 4506-T covers the current year and the prior 3 processing years, and the IRS must receive the signed form within 120 days of the signature date (Form 4506-T). Allow 2 to 3 weeks after e-filing and 6 to 8 weeks after mailing a paper return before requesting a transcript. A "No record of return filed" result may only mean the return is not processed yet.
A sole proprietor reports business income on Schedule C of the personal Form 1040 (Publication 334), so that seller's transcript is the personal return transcript and shows personal items too. Form 4506-T covers the Form 1040 series (Form 4506-T); a business tax account is not yet open to an LLC that files as a sole proprietor (IRS). Agree in advance which years the seller will show. A seller who will not produce or authorize a transcript leaves the filed figures unverified; treat them as a claim.
What if the seller says much of the business is cash or "off the books"?
Treat cash that no record shows as unproven. A business must report all income it receives, in cash or otherwise, including income no payer reported on a Form 1099 (Publication 334), so money kept "off the books" is missing from the seller's records and, unless reported some other way, from the return.
A cash business can still be tested with records the seller does not control:
- Purchases. Supplier invoices and the bank payments for them. In a retail or wholesale business, divide gross profit (net receipts minus the cost of what was sold) by net receipts and compare the percentage with the seller's markup policy; a large difference may show that sales, purchases or inventory are wrong (Publication 334).
- Daily sales reports. Register or point-of-sale reports compared with the deposits and the sales tax returns.
- Deposits. A bank deposit analysis alone is a weak test when much of the cash is never deposited (Internal Revenue Manual 4.10.4).
A service business paid in cash, with no invoices, appointment records or deposits, gives you nothing to test.
If the cash was left off the return, the exposure is the seller's first, and the IRS may have longer than the usual 3 years to assess federal income tax: 6 years when income left off the return is more than 25% of the gross income stated on it (for a business, sales before the cost of sales), and no limit when no return was filed or the return was false or fraudulent with intent to evade tax (26 U.S.C. 6501). Whether that exposure follows you depends on what you buy; see buying a business.
Which differences are normal, and which are red flags?
A gap is more likely benign when documents explain it, and more likely a red flag when they do not. The usual causes, and what turns each into a red flag:
| Difference | Can be normal when | Red flag when |
|---|---|---|
| Accounting method: the profit and loss records income when earned, the return when received, or the reverse (Publication 538) | The gap shifts sales between years and shrinks over several years | The gap grows each year, or the seller cannot say which method each uses |
| Depreciation: the return spreads equipment cost over several years, or deducts some or all of it in the year of purchase under section 179 or bonus depreciation (Publication 334) | The schedule lists equipment you can see, and its amount equals the gap | The schedule is missing, or lists assets that are not there |
| Owner costs: a personal car, relatives on payroll, travel | Each has a receipt or payroll record, the business part is separated from the personal part, and employee pay is reasonable and for services performed (Publication 334) | No receipts, a relative who does no work for the business, or personal bills booked as business costs |
| Sales tax inside revenue | It is shown separately and matches the sales tax returns | It makes up the gap, or sales tax collected and remitted do not agree |
An add-back is a cost the seller removes from expenses to show a higher profit. The personal part of a mixed cost is generally not deductible (Publication 334), so an owner cost the seller adds back may also be one the seller deducted on the return. How a buyer or lender tests each add-back is in add-backs and seller's discretionary earnings.
How do I check inventory, equipment and what the business owes?
Check each against a record that comes from outside the seller's own spreadsheet.
| Item | Test |
|---|---|
| Inventory | Year-end count sheets and purchase invoices: opening inventory should match last year's closing inventory unless the seller explains the difference (Publication 334); count the stock yourself before closing. Valuation is in inventory or supplies |
| Equipment | Asset list, depreciation schedule (Form 4562), titles and leases: every item is on site, owned not leased, and free of liens. A federal tax lien covers all of a taxpayer's property, and the IRS files a public notice of it (IRS) |
| Payroll taxes | Forms 941 and 940, deposit records and notices: filed on time and paid; the employment tax return transcript shows what the IRS holds (IRS) |
| Income tax balance | The tax account transcript, with penalties and interest (IRS), or the amount owed in the seller's business tax account, if it has one (IRS) |
| Sales tax | State returns, notices and any payment plan: returns filed for every period; sales agree with the deposits |
| Loans and leases | Statements, schedules and agreements: balances match the balance sheet; payments appear in the bank statements; who takes over each one |
What can I be liable for after I buy, and what do states ask me to do before paying?
Possibly, even in an asset purchase: state law can reach the buyer, and some states ask the buyer to notify the tax agency before paying. Whether you take on the seller's old tax debts depends first on whether you buy the company or its assets; see buying a business. State bulk sale laws, which cover a sale of a business's assets in one deal, can make the buyer of substantially all of its inventory or equipment liable for its debts when creditors are not notified; most states have case law that holds a corporate buyer liable when one corporation sells its assets to another and the sale is in effect a merger or continuation of the seller; and a buyer who expressly or impliedly agrees in a contract to assume the debt is liable for it (Internal Revenue Manual 5.17.14). Rules and forms differ by state. Two examples:
| State | What the buyer does before paying |
|---|---|
| New York | When business assets are bought from a seller who must collect sales tax (buying a corporation's stock is not a bulk sale), file Form AU-196.10 at least 10 days before paying for or taking possession of any of the assets, whichever comes first. Send it by registered mail, certified mail with return receipt, or hand-delivery to the Tax Department in Albany; by any other method it counts only from the day the department receives it, and the buyer must prove receipt. File a revised form if the closing date changes. The state answers within 5 business days with a release (Form AU-197.1) or a Notice of Claim (Form AU-196.2); if a proper, timely notice draws no claim in that time, the buyer is not liable. After a claim, the full price goes into escrow; the state states the amount due within 90 days of receiving the form, and the buyer pays it from escrow, up to the price or the assets' fair market value, whichever is greater. A buyer who skips the steps may be personally liable for the seller's unpaid sales and use tax. The seller must give prospective buyers Form TP-153, but the buyer's duties and liability apply even if it does not. A release does not clear existing liens on the assets (New York). |
| California | The buyer of a business or its stock of goods generally must withhold enough from the price to cover the seller's unpaid taxes and fees owed to the state's tax and fee agency (CDTFA), such as sales and use tax, with interest and penalties, or can be held personally liable up to the price. A Certificate of Payment releases that duty. For sales and use tax, the duty also ends if CDTFA sends neither a certificate nor a notice of the amount due within 60 days after the latest of the buyer's written request, the sale, or the date the seller's records are available for audit. To enforce the duty, CDTFA must serve a notice of successor liability within 3 years after it is notified of the purchase (Regulation 1702). In practice a clearance can take 60 days or more, especially when an audit is needed and the seller's books are not at hand; an escrow company can request it (California). |
For any other state, ask that state's tax agency what it requires before you pay a deposit or take possession. These steps take time, so build them into the closing date.
Do I need an accountant to review the books before I sign, and what should they test first?
A review can be worth the cost when the price rests on numbers you cannot trace yourself, when a deposit is at risk, or when the seller explains gaps without records. Ask for these tests in this order:
- Bank and card deposits against reported sales, month by month.
- Sales and profit against the return and the IRS transcript.
- Payroll and sales tax filings against the wages and sales on the books.
- Each owner cost the seller adds back, against a receipt and a reason.
- The inventory count, asset list and debts against the balance sheet.
Agree the tests in writing, so you know what was and was not checked, and have the seller's signed access to records and transcripts in hand before it starts. A quality of earnings report is a deeper accountant review that adjusts the seller's earnings figure, and a larger engagement: see whether you need one and what it costs.
The offer is already accepted and the numbers still don't tie: what are my options?
The options depend on what the purchase agreement and deposit terms say, so have your attorney read them first, especially the date the review period ends and the date the deposit stops being refundable. These are contract terms, not tax rules.
- Ask for the missing records in writing, with a date. If they take time, ask to extend the review period: a mailed transcript request is usually processed within 10 business days (Form 4506-T), and California's tax and fee clearance can take 60 days or more.
- Check what the records verify before you discuss price. Price terms are for you, your lender and your attorney; the figure the records support is the input (see the restaurant example). When the assets bought make up a business that goodwill could attach to, both sides report the price allocation on Form 8594 (IRS).
- Ask your attorney about holding back part of the price until a figure is verified, as New York's escrow step does for unpaid sales tax.
- Confirm the deposit date before you accept an explanation. Whether the deposit can still be refunded depends on the contract; an explanation without records leaves the gap open.
Example
All figures are in US dollars.
A restaurant with $260,000 of sales no record supports
The seller's profit and loss statement shows $900,000 of sales. The return shows $640,000 of sales, its only gross income. After removing transfers, loan deposits and sales tax, bank and card deposits support $640,000. The seller says the rest was cash, but no register reports, supplier invoices or sales tax returns support it. The extra $260,000 has no records and is not on the return, so the price rests on $640,000. If the seller is right that it was cash, it was left off the return, and its sales tax went unpaid too. For income tax, $260,000 is more than 25% of the $640,000 reported ($160,000), so the IRS may have 6 years to assess it, which is the seller's exposure first. Some states make a buyer answer for unpaid sales tax (see the New York shop below).
A service firm with a $90,000 profit gap
The seller's earnings figure is $210,000, after adding back owner costs and depreciation that the return deducted. The return shows $120,000 of profit, a $90,000 gap. Assume the return deducted $60,000 of owner costs (the owner's car, a family member who works in the business, travel) and $30,000 of depreciation. Receipts and payroll records support the $60,000. Those records show what was spent; the personal part of the car and travel is generally not deductible, which raises a question about the return. The depreciation schedule supports the $30,000. The gap closes only because a document supports each piece; a piece without one stays in dispute.
A New York shop with unpaid sales tax
A buyer agrees to pay $350,000 for the assets of a retail shop (not stock in its company) whose owner must collect sales tax. The seller owes $18,000 of sales tax. The buyer files the bulk sale notice at least 10 days before paying. The state answers with a Notice of Claim, the buyer puts $350,000 in escrow, and the state states the amount due. The buyer pays $18,000 to the state from escrow and $332,000 to the seller, so the tax is paid before the seller is. Sales tax the buyer owes on any taxable equipment is separate.
Different for you?
- The offer is accepted, the numbers do not tie, and the seller explains without records: which numbers a price can rest on is a professional judgment, and the review period may end when the deposit stops being refundable. Get bookkeeping help before that date.
- The seller has no usable books, missed returns, cash sales, several entities, or money passing through accounts outside the US: these need professional judgment on which numbers a price can rest on; get bookkeeping help before you commit.
- You need to decide between buying assets and buying the company, or worry about old tax debts: see buying a business.
- A lender or you want a full quality of earnings report: see whether you need one and what it costs.
- The seller's profit includes owner perks: see add-backs and seller's discretionary earnings.
- Card payouts do not match sales: see reconciling sales and payouts.
- You are the seller: see selling your business.
Figures on this page
| Figure | Value | Source |
|---|---|---|
| Federal Form 1099-K marketplace payment threshold Marketplace or payment-app payments must exceed this amount and exceed 200 transactions before federal third-party network reporting is required; payment-card transactions have no such threshold. | $20,000 | IRS: Understanding your Form 1099-K Checked |
| Years for which a return transcript is available Return transcripts are available for the current year and returns processed during the prior 3 processing years. | The current year and the prior 3 processing years | IRS: Form 4506-T, Request for Transcript of Tax Return (April 2025), line 6a Checked |
| IRS receipt window for a signed Form 4506-T The IRS must receive Form 4506-T within this period after the signature date. | 120 days | IRS: Form 4506-T, Request for Transcript of Tax Return (April 2025) Checked |
| Wait after e-filing before requesting a business tax transcript For a return filed electronically; "No record of return filed" may mean the return is not processed yet. | 2 to 3 weeks | IRS: Get a business tax transcript Checked |
| Wait after mailing a paper return before requesting a business tax transcript For a return filed on paper. | 6 to 8 weeks | IRS: Get a business tax transcript Checked |
| General IRS assessment period for an income tax return After the return was filed; a return filed before its due date counts as filed on the due date (26 U.S.C. 6501(a) and (b)(1)). Longer or unlimited periods apply in the cases in section 6501(c) and (e). | 3 years | US Code: 26 U.S.C. 6501, limitations on assessment Checked |
| IRS assessment period when omitted income passes the substantial-omission test After the return was filed, when the income left off is more than the share of gross income stated on the return set in us.assessment.substantial-omission-threshold (26 U.S.C. 6501(e)(1)(A)). | 6 years | US Code: 26 U.S.C. 6501, limitations on assessment Checked |
| Omitted gross income that extends the IRS assessment period to 6 years More than this share of the gross income stated on the return (26 U.S.C. 6501(e)(1)(A)(i)); for a business, gross income means total receipts before cost of goods sold | 25% | US Code: 26 U.S.C. 6501, limitations on assessment Checked |
| New York bulk sale: notice to the Tax Department before paying or taking possession File Form AU-196.10 at least this long before paying for or taking possession of any business assets, whichever comes first. | 10 days | New York State: Tax Bulletin ST-70, Bulk Sales Checked |
| New York bulk sale: Tax Department response after a proper notice The department issues a release (Form AU-197.1) or a Notice of Claim (Form AU-196.2) within this time after receiving Form AU-196.10. | 5 business days | New York State: Tax Bulletin ST-70, Bulk Sales Checked |
| New York bulk sale: Tax Department states the amount of sales tax due After a Notice of Claim (Form AU-196.2), the department notifies the purchaser and the seller of the amount due, if any, within this time of receiving Form AU-196.10. | 90 days | New York State: Tax Bulletin ST-70, Bulk Sales Checked |
| California successor liability: CDTFA's time to issue a certificate or an amount notice before the buyer's duty to withhold ends Regulation 1702(c): the buyer is released from the duty to withhold if CDTFA issues neither a Certificate of Payment nor a notice of the amount due within this time after the latest of the buyer's written request for a certificate, the sale of the business or stock of goods, or the date the former owner's records are made available for audit. | 60 days | California CDTFA: Regulation 1702, Successor's Liability Checked |
| California successor liability: time for CDTFA to serve a notice of successor liability Not later than this long after the date CDTFA is notified of the purchase of the business or stock of goods (Revenue and Taxation Code 6812(c) and 6814(a); Regulation 1702(d)(1)). The buyer has 30 days after service to petition for reconsideration. | 3 years | California CDTFA: Regulation 1702, Successor's Liability Checked |
| California tax and fee clearance for a business purchase: time it can take The state says a clearance can take this long, especially if an audit is required and the seller's books and records are not immediately available. | 60 days or more | California CDTFA: Publication 74, Notifying CDTFA (successor's liability and clearance) Checked |
| Processing time for most Form 4506-T transcript requests The form must reach the IRS within 120 days of the signature date. | 10 business days | IRS: Form 4506-T, Request for Transcript of Tax Return Checked |
Primary sources
- IRS: Publication 334, Tax Guide for Small Business
- IRS: Publication 538, Accounting Periods and Methods
- IRS: Publication 583, Starting a Business and Keeping Records
- IRS: Get a business tax transcript
- IRS: Form 4506-T, Request for Transcript of Tax Return
- IRS: Instructions for Form 8821, Tax Information Authorization
- IRS: Business Tax Account
- IRS: Income Verification Express Service (IVES)
- IRS: Understanding your Form 1099-K
- US Code: 26 U.S.C. 6501, limitations on assessment
- IRS: Internal Revenue Manual 4.10.4, Examination of Income
- IRS: Internal Revenue Manual 5.17.14, Transferee and Other Third Party Liability
- IRS: Understanding a federal tax lien
- IRS: Instructions for Form 8594
- New York State: Tax Bulletin ST-70, Bulk Sales
- California CDTFA: Publication 74, Notifying CDTFA (successor's liability and clearance)
- California CDTFA: Regulation 1702, Successor's Liability
About this guide
Published by Cloud Accounting under standing professional approval. This version has no separately recorded personal review. It explains general rules for the tax year shown. It is not advice for your situation.
Changes
- : First published.