You Can Backdate Agreements in Business Legally

Chris, my business partner and I are breaking up the partnership. I want out because we have issues. I don’t want to be responsible for this year’s bills. Can we backdate a deal to get me out legally?

YES, It Is Legal to Backdate a Business Buyout or Other Restructure

Many people are trying to work out new arrangements with their business partner but find themselves in bad place on the calendar. Despite both parties agreeing to a change, it could take months to worth out the terms. Don’t worry. Some agreements can be legally backdated for years.

The easy answer is “Yes”, you can backdate. There are things to be careful of when backdating. Let’s take a look how to do it right.

The First Question: Why Are We Backdating the Deal?

Of course, the answer is always the same. You don’t want to carry all the accounting hassles into another year. One partner doesn’t plan to take income in the current year and doesn’t want the current year’s liabilities. And, there is that legal case pending against the business and you’d like to avoid that too, right? Whoa. Just a minute.

Are you trying to escape the consequences of an event that’s already happened? If the partners flip a coin and decide who will be free of a lawsuit already filed against the business, it’s not going to be a legal backdate.

You want to be careful about why you are backdating. Let’s look at the two classifications of backdating; one is acceptable and the other is not.

The Backdating Test

In order to determine if it’s okay to backdate we must determine if we are memorializing a deal or committing fraud. Easy, right? Actually it is pretty easy. Let’s look at some examples.

Partnership Buyout #1

The are three partners in a business. One partner decides that she no longer want to be a partner and is willing to sell her interest in the business to the other partners. She makes her intention known on December 1, 2019. The other partners begin negotiations with her on the price and terms of a buyout. They offer $20,000 for her interest in the business. She insists that her share is worth $300,000. Despite numerous meetings, by June of 2020, the parties are still trying to find an acceptable compromise.

In December of 2020, a deal is reached for $175,000 in cash but the remaining partners want the deal dated effective December 31, 2019. Can we do that?

The answer is yes. We are simply memorializing (creating a record) of a deal that was made in principle in a previous time. If the partner worked in 2020, we have to consider how to report those earnings. If the sale happened in the prior year, payments to the departing partner will be treated (and taxed) as wages. We might reconsider the sale date. Regardless, it’s perfectly legal to backdate under these circumstances. Why? We are memorializing a deal that was begun in an earlier time.

Partnership Buyout #2

A business has 2 partners. An employee is injured on the job and the business is in deep trouble. The partners have a great idea that can save the business. One partner buys out the other partner and hands over all the cash reserves the business has. They agree to backdate the sale to well before the accident. The departing partner also takes the bulk of the inventory and key equipment as part of his buyout. Legal? No.

In this case, the backdating is clearly designed to escape the consequences of the accident. There was no prior discussion about a buyout. And, even if there was, this deal was clearly designed as a way to fraud the employee from a potential settlement.

Memorializing or Fraud? How to Decide

This is a pretty easy question most of the time. Of course, there are always cases that fall in the gray area, but if the deal doesn’t hurt anyone, and if you have some basis for a backdate, you won’t have a problem.

Don’t let the calendar keep you from getting out of a bad situation. You can start the discussions now and backdate to the prior year for the sake of keeping your books simple as long as income is properly accounted.

How Far Back Can You Go?

I’m not sure there is a legal limit so long as it’s clear that the deal memorializes a transaction and is not designed to fraud anyone (including the government). I have participated in deals that were backdated by years without issues. That’s rather unusual but there are times when backdating makes great sense.

“Don’t let the calendar keep you from getting out of a bad situation. You can start the discussions now and backdate to the prior year for the sake of keeping your books simple.”