Tax Reps and the Disclosure Schedule: What a Startup Lists

What do the tax reps in a stock purchase agreement usually confirm?

The tax reps in a seed or Series A stock purchase agreement usually have the company confirm that every required return was filed, every tax due was paid, payroll tax was withheld and paid over, and no audit, notice or claim is open. Each rep is a statement of fact. If a fact is not true, the company lists it on the disclosure schedule as an exception rather than signing a rep it would breach.

The wording differs by deal, so read the reps in your draft. The common ones and the evidence behind each:

A case is not simple when the company has a year with no return filed, a foreign owner or subsidiary, staff in more than one state, a founder without 83(b) proof, or an open notice. Each of these can keep a year open with no end date or create an amount still owed.

Gather: filed federal and state returns, IRS and state account records, every notice, payroll filings, Forms 1099 and W-9s, each founder's 83(b) copy with proof of mailing, and the option ledger with Forms 3921. For what goes in the data room, see financial records investors ask for.

Which tax items belong on the disclosure schedule as exceptions?

The disclosure schedule lists every tax fact that makes a rep untrue as written. Listing a known gap discloses it; leaving it off risks a breach of the rep.

Items that commonly belong there:

• A return not filed or filed late, by tax, year and jurisdiction
• A balance owed, including one in a payment plan
• An open IRS or state notice, audit or appeal
• A state where the company may have had to register or file but did not
• Payroll filed in fewer states than where people worked
• Workers paid as contractors whose status is in question
• Sales tax not collected on sales that may be taxable
• A missing 83(b) copy, Form 3921 or other equity filing
• A signed agreement extending the time to assess tax

For each item give the tax, the period, the agency, the amount if known and the status of the fix. Counsel decides how to word it. For sizing uncollected sales tax, see sales tax exposure found in due diligence. For contractor questions, see contractors found misclassified in due diligence.

Which tax years are still open, and why does that matter?

The IRS generally has three years after a return is filed to assess more tax; a return filed early counts as filed on its due date (26 U.S.C. 6501). A year with no return filed never closes. That is why "every return was filed" is the rep that matters most: a gap in an unfiled year stays open until the return goes in.

The foreign information rule keeps the related tax year open, not just the penalty for the missing form. Where the failure had reasonable cause, it keeps open only the items related to the failure (26 U.S.C. 6501(c)(8)). Each state sets its own assessment periods, so check every state on the list.

How do we prove returns were filed and tax paid?

IRS transcripts are the main proof: they show what the IRS received, when, and what is still owed. A copy of the return shows only what the company prepared.

The company can get business transcripts three ways: its business tax account, Form 4506-T by mail, or the IRS business phone line (IRS). For a C corporation, the business tax account's Designated Official must be an officer and current employee who received a W-2 for the most recent tax filing year and can legally bind the company. A founder not on payroll may not qualify, so plan for Form 4506-T or an authorized CPA.

The entity transcript is worth pulling: it shows the filing requirements on the IRS's records, so a requirement the company never met, such as quarterly Form 941, needs to be resolved before signing a "returns filed" rep. Allow 2–3 weeks after e-filing, or 6–8 weeks after paper filing, before a transcript shows the return; "No record of return filed" may only mean it is not processed yet (IRS).

For states, use each state's online business account, filed returns and payment records. Some states issue a letter of tax standing. California's Franchise Tax Board, for example, issues an entity status letter showing whether the entity is in good standing with the Franchise Tax Board; it does not reflect status with other agencies. For Delaware status and the yearly calendar, see Delaware C corporation taxes for startups.

Which states have we filed in, and where might we have had to?

Build one table of every state the company touches, then compare it with where it actually filed. A state where people work, where the company has an office or property, or where it sells may require registration and returns, and the thresholds differ by state.

A blank where a filing was required becomes an exception on the schedule. Fixing those gaps is covered in tax clean-up before investor due diligence.

Payroll, contractors and 1099s: what do we check before signing?

Before signing a withholding rep, confirm that every quarterly Form 941 and annual Form 940 was filed and paid, and that W-2 totals match. The IRS compares Form 941 data with the W-2 data sent to the Social Security Administration (IRS), so a mismatch can surface later as a notice. A founder or officer responsible for paying over withheld tax who willfully fails to can be personally liable for a penalty equal to the unpaid amount (26 U.S.C. 6672).

Check:

• An employment tax transcript or account transcript for each quarter
• A state withholding and unemployment account in each state where staff worked
• A W-9 for each contractor, and Form 1099-NEC for each one paid $2,000 or more for current-year payments ($600 for earlier years); payments to corporations are generally exempt (IRS)
• Founders and officers paid outside payroll

The IRS says to keep employment tax records for at least 4 years after the tax is due or paid, whichever is later (IRS). If early team members look like employees, see contractors found misclassified in due diligence.

Founder 83(b) elections and option filings: what proof do we keep?

For each founder with vesting shares, the company keeps its own copy of the 83(b) election and proof that it was filed within 30 days of the share transfer. The regulation requires the founder to file with the IRS and give the company a copy (26 CFR 1.83-2).

Proof of timing is usually a postmarked mailing receipt or, for a Form 15620 submitted through an IRS online account, the downloaded copy shown after a successful submission (IRS). Under 26 U.S.C. 7502, registered mail is prima facie evidence of delivery and its registration date counts as the postmark date; for certified mail, the postmark on the sender's receipt counts (26 CFR 301.7502-1). Keep the signed election, the receipt and any IRS acknowledgment together.

For options, keep the option ledger: each grant, the valuation behind its exercise price, each exercise, and a filed Form 3921 for each transfer of stock on an incentive stock option exercise (IRS). A missing Form 3921 goes on the schedule. A late or missing 83(b) is covered in founder shares that vest; how a founder reports one is in reporting founder stock after an 83(b). If investors also ask the company to confirm QSBS, see the small business stock exclusion for startups.

Notices, audits and payment plans: how are they listed?

List every open notice, audit, appeal and payment plan by agency, form, period, notice number, amount and current status. A balance in a payment plan is still owed, so it is an exception to a "tax paid" rep.

• Notices: keep each one. If the company disputes it, it should respond by the due date to protect its appeal rights (IRS). The business tax account shows IRS notices online.
• Payment plans: list the plan and the balance left. Unpaid tax may lead the IRS to file a Notice of Federal Tax Lien (IRS).
• Audits and consents: list any open examination and any signed consent extending the assessment period (26 U.S.C. 6501(c)(4)).
• Closed items: if a notice was paid or resolved, keep the closing letter or the transcript showing a zero balance.

What can a CPA confirm, and what does counsel draft?

Counsel drafts the reps and the disclosure schedule and advises on legal terms such as indemnities. The company makes the reps, and its officers sign. A CPA supplies and checks the facts behind them.

A CPA can, with a signed Form 8821 or power of attorney, pull the company's transcripts through the IRS Transcript Delivery System, and the complete business entity transcript through the Practitioner Priority Service line (IRS). From those and the company's records, a CPA can prepare:

• A filing table by tax, year and state, with filing dates
• Transcripts showing balances, penalties and payments
• A list of notices and their status
• Payroll and 1099 filing status
• Estimates of amounts owed for the items being fixed

What a CPA does not do is decide the legal wording of an exception or the deal's risk terms. Those stay with counsel.

Example

These examples are illustrative; all amounts are in US dollars.

Second state never filed

A company started payroll for an engineer in a second state last year. It set up withholding there but never filed that state's corporate income tax return, which, in this example, the state required once an employee worked there. The schedule lists the state, the year, the missing return and the fix underway: registration filed and the return in preparation.

IRS notice still open

The IRS sent a penalty notice of US$4,000 for a Form 1120 it treats as filed late. The company believes it filed on time and has replied with proof. The schedule lists the notice number, the tax year, the amount and that it is being contested. The tax account transcript shows the assessed penalty until the IRS decides.

Missing 83(b) proof

A co-founder signed an 83(b) election but cannot find the mailing receipt, and the company never received its copy. The schedule lists the missing proof for that co-founder. The founder's own steps are handled separately.

Different for you?

• Returns or state registrations are missing: fix them using tax clean-up before investor due diligence, and get startup tax help before the schedule is final.
• Investors found uncollected sales tax: see sales tax exposure found in due diligence.
• Contractors look like employees: see contractors found misclassified in due diligence.
• A founder's 83(b) is missing or late: see founder shares that vest; for the founder's own return, see reporting founder stock after an 83(b).
• The company is being sold, not raising: see tax clean-up before selling your startup.
• You need the records for the data room: see financial records investors ask for, and use startup tax help to assemble the filing table.