Navigating State Tax Implications in M&A Transactions

Mergers and acquisitions (M&A) are already intricate processes, and state tax issues can add another layer of complexity. With the expansion of tax obligations following the Wayfair Supreme Court decision and the rise of economic nexus laws, businesses of all types must navigate evolving requirements that extend beyond physical presence in a state.

Here’s the deal (pun intended): state tax compliance isn’t just a formality; it can significantly impact the success of an M&A transaction. From understanding nexus requirements to ensuring airtight tax documentation, every detail counts.

This article explores key state tax considerations businesses should address before, during, and after M&A transactions. We’ll cover due diligence, navigating nexus laws, and maintaining accurate documentation. With expert insights from industry leaders and the team at Miles Consulting Group, you’ll gain practical strategies to protect the value of your transaction and avoid costly surprises.

Whether you’re buying or selling, this playbook is designed to help you tackle tax complexity with confidence. Let’s get started.

This is what we’ll be covering:

  1. The Importance of Due Diligence
  • Role of due diligence in identifying tax liabilities
  • Risks for buyers and sellers related to state tax compliance
  • Benefits of addressing tax issues early in the M&A process
  1. Key Tax Concerns in M&A
  • Economic nexus and state sales tax obligations
  • Ambiguities in the taxability of products and services
  • Documentation issues: missing exemption certificates and filings
  • Legacy liabilities: unresolved back taxes and tax audits
  1. Economic Nexus and Its Implications
  • The Wayfair decision and its impact on nexus
  • Implications of economic nexus for multistate businesses
  • State-specific challenges and variations in tax treatment
  1. Navigating State Tax Exemptions
  • Importance of exemptions in M&A deals
  • Best practices for managing exemptions and avoiding liabilities
  1. How Miles Consulting Group Can Help
  • Nexus studies and taxability reviews
  • Documentation cleanup and audit defense
  • Preparing for M&A readiness with Miles Consulting Group

Not quite what you need? Let’s talk. Reach out to us at info@milesconsultinggroup.com.

1. The Importance of Due Diligence

State tax issues often arise during M&A due diligence and tend to catch both buyers and sellers off guard. Buyers typically scrutinize the target company’s compliance with state tax laws, focusing on any liabilities that could complicate negotiations or inflate the final deal price. If tax obligations are not properly addressed, the buyer may be left inheriting unexpected liabilities, which could delay or even derail the transaction.

Sellers may unknowingly overlook obligations such as economic nexus or taxability of digital services. These oversights can lead to reduced valuations, delays in closing the deal, or even deal termination. Addressing state tax matters proactively during due diligence ensures that both parties are aware of potential risks, ultimately leading to a smoother and more successful transaction.  In our practice, we often help to support the seller in a transaction. Generally, the buyer’s side is already well represented by attorneys and accountants. But the seller is often caught off guard by potential sales tax exposure.  And the truth is, many sellers DO have exposure, but in our experience, the exposure is often much lower than the buyer’s side due diligence because the buyer side tends to be ultra-conservative about successor liability, which is understandable. But we are often able to reduce the exposure significantly for the seller.

2. Key Tax Concerns in M&A

Here are some of the most common state tax concerns that arise in M&A transactions:

  1. Economic Nexus: Many businesses trigger nexus across multiple states due to their operations, creating obligations to collect and remit sales tax in various jurisdictions.
  2. Taxability Ambiguities: Taxability rules for products and services vary by state, leading to confusion and risk, especially for companies offering cross-border services or goods.
  3. Incomplete Documentation: Missing or outdated exemption certificates, filings, or other records can increase risks and delay deal closures.
  4. Legacy Liabilities: Unresolved back taxes or state audits may transfer to the buyer, creating successor liability concerns.

3. Economic Nexus and Its Implications

The landmark South Dakota v. Wayfair decision by the U.S. Supreme Court in 2018 fundamentally reshaped the landscape of sales tax collection. The Court ruled that a state could impose sales tax obligations on businesses even if they lacked a physical presence in that state. This ruling expanded the concept of “economic nexus,” meaning businesses with sufficient economic activity in a state—such as meeting a minimum sales threshold—must collect and remit sales tax in that state.

This change creates additional due diligence challenges for M&A transactions. Buyers must assess whether the target company has met the nexus thresholds in states where they conduct business or sell products. If the target has been non-compliant with these obligations, the buyer could inherit tax liabilities, including penalties and interest.

The Digital Dilemma – State-Specific Nexus and Taxability Rules of Digital Goods

The interpretation of nexus and the taxability of digital products, services, and SaaS offerings varies by jurisdiction. Understanding these nuances is vital in determining potential liabilities – here are a few examples of how fragmented these rules can get per state:

  • New York: New York does not treat digital products as taxable because New York does not consider a digital product as tangible personal property (e.g., digitized visual files such as art and book text) while others—such as cloud-based software—are taxable. Buyers should carefully assess the taxability of the target’s offerings and ensure compliance with New York’s sales tax laws.
  • Texas: Texas imposes sales tax on services like data processing partially, exempting from tax twenty percent of the charge for data processing services. While digital products are taxable at the full sales tax rate in Texas. Buyers and sellers must evaluate whether the target’s services fall under taxable categories and are fully taxable, as non-compliance could result in retroactive tax obligations.
  • California: California in general does not impose taxation on digital goods. There must be a transfer of tangible personal property for a product to be taxable. Digital products and cloud-based software is generally not considered tangible personal property in California. The state seemingly does not have an aggressive stance on enforcing sales tax in the e-commerce and digital product sector.

At Miles Consulting, we specialize in M&A due diligence – particularly where Saas is concerned. Don’t do it alone. Let us help you.

Case Study

We recently worked with a wonderful client who had to deal with a few of these nexus and due diligence issues. We solved her problem, and the sale of her business was a resounding success. Here’s what happened:

Mid-Sized Manufacturing Company Overcomes Sales Tax Challenges During Due Diligence

When our client, the owner of a family-owned manufacturing company, found herself in the middle of the due diligence process to sell her business, a significant obstacle emerged: her company had unknowingly created sales tax obligations in many states due to its nationwide shipments. This revelation posed a serious risk to the sale, as the potential buyers flagged the issue during their review. Without immediate action, the deal could collapse or result in substantial financial liabilities.

“I found out that I wasn’t aware of or compliant with the State Sales Tax laws while trying to sell my company. After consulting with Monika and her team, I understood that I had reached nexus in 27 states. I knew this was not something I was prepared to navigate alone and needed to get in compliance, preparing and filing VDAs and back returns so that I could move forward in selling my company,” remarked our client.

How Miles Consulting Group Helped:

Understanding the urgency and complexity of the situation, Miles Consulting Group implemented a strategic plan to address the company’s multi-state sales tax exposure. Key actions included:

  • Preparing and filing Voluntary Disclosure Agreements (VDAs) and retroactive filings across all 27 states where nexus was identified.
  • Managing the audit process and ensuring compliance with ongoing monthly returns and filings until the sale was finalized.
  • Providing clear communication and structured support to make the overwhelming process manageable.

Results:

Thanks to Miles Consulting Group, our client successfully resolved the sales tax issues that had surfaced during due diligence, paving the way for the sale of her business. Accurate tax filings mitigated financial risks, and the buyer’s concerns were addressed.

Find out more about our M&A Tax Due Diligence Services.

4. Navigating State Tax Exemptions

State tax exemptions, such as resale certificates, manufacturing exclusions, and tax credits, can significantly affect a company’s tax obligations during M&A transactions. Proper management of these exemptions is crucial to avoiding unnecessary liabilities. The application of exemptions can vary greatly depending on the type of transaction (e.g., asset vs. stock sale) and the nature of the business. Mismanagement of exemptions can result in significant tax liabilities, especially if taxability is challenged post-closing.

Best Practices for Managing Exemptions

To minimize risks, businesses should adopt best practices for managing exemptions during M&A:

  1. Organize Documentation:
    Ensure that all exemption certificates, sales tax filings, and other relevant documents are current, valid, and properly stored. Keeping these records easily accessible helps streamline audits and due diligence, reducing the risk of complications during the transaction process.
  2. Understand State Rules:
    Exemption rules differ across states and may vary based on the type of transaction or business activities. It’s crucial to understand the specific exemption rules in each jurisdiction to ensure compliance and avoid missing opportunities to reduce tax liabilities.
  3. Conduct Periodic Audits:
    Regularly audit exemption documentation to identify any discrepancies or outdated records before finalizing the transaction. Addressing potential issues early helps prevent complications and unexpected liabilities in post-closing audits.

By following these best practices, businesses can effectively navigate state tax exemptions, ensuring compliance and minimizing risks throughout the M&A process. Proper exemption management is essential to avoid financial pitfalls and ensure a smooth transaction.

5. How Miles Consulting Group Can Help

At Miles Consulting Group, we specialize in state sales tax remediation as a result of M&A transactions. We most often assist the seller in mitigating their exposure and maximizing the amount of money they get to keep related to state tax exposure. Our services include:

  • Nexus Studies: Identify economic nexus obligations across states, helping companies assess where sales tax may be due.
  • Taxability Reviews: Clarify how SaaS products are taxed in various jurisdictions, ensuring that your business complies with state-specific laws.
  • Documentation Cleanup: Ensure that exemption certificates and sales tax filings are accurate and audit-ready, minimizing the risk of post-transaction disputes.
  • Audit Defense: Protect your business during state audits, helping to resolve issues quickly and minimize penalties.
  • M&A Readiness: Prepare for buyer scrutiny by proactively addressing tax liabilities and ensuring your business is in compliance with all relevant state tax laws.

State tax compliance is a critical component of successful M&A transactions. For all parties involved, addressing nexus, exemptions, and documentation early can safeguard valuations, streamline negotiations, and reduce risks. Whether you’re buying or selling, understanding the nuances of state tax laws is essential for a smooth, compliant transaction.

Don’t know where to start? We do. Contact Miles Consulting Group today to ensure your M&A transaction is smooth, compliant, and successful. Book a consultation, drop us a line, or send us an email at info@milesconsultinggroup.com.