Considering the proper aspects of state and local tax implications is an important piece of the due diligence strategy for anyone looking to sell or acquire a business.
Here, we’ve outlined a few frequently asked questions about state and local tax (SALT) due diligence and the answers that buyers and sellers should know before a transaction.
This article was adapted from The Wrap Podcast Episode: Making Deals with a Grain of SALT. Listen to the full episode below.
What is due diligence?
Due diligence is the process of identifying and analyzing the risk associated with acquiring a business or selling a business. Tax risk, particularly state and local tax, is a key part of that analysis.
There are many different types of taxes that businesses should take into consideration, such as:
- property taxes;
- sales and use taxes;
- gross receipts taxes;
- income taxes; and
- franchise taxes.
Each of these tax types have unique rules and implications, and state and local jurisdictions apply those taxes in different ways. It can get complex quickly based on where a company is operating.
That’s why it’s important to take a strategic approach to help you to minimize your tax burden associated with a transaction.
What aspects of a transaction can affect a SALT due diligence strategy?
There are many different aspects of a transaction that can influence a company’s due diligence strategy when it comes to state and local tax. A few of the areas to consider that can have the largest impact are:
- Type of transaction (stock deal vs. an asset sale)
- Size and purpose of transaction
- Nature of the parties’ businesses
- Time constraints
- Available resources
- Risk exposure and tolerance level of parties involved
- Parties’ geographic footprint and business presence.
What should a seller do when it comes to state and local tax considerations in order to prepare for a potential sale?
If you’re looking to sell your business, it’s best to begin early (12 to 18 months in advance of a sale) in preparing for and anticipating the due diligence actions you should take when addressing state and local tax.
When developing your SALT due diligence strategy, businesses should:
- Consider sufficiency of state tax reserves currently on the balance sheet
- Identify areas that may create exposure (like non-filings and economic nexus) that aren’t currently reserved
- Document your state and local tax audit history and status of current audits
- Ensure you’ve taken the right steps to comply with changes resulting from recent tax law changes (like South Dakota v. Wayfair and The Tax Cuts and Jobs Act)
What should buyers know about state and local tax due diligence considerations?
If you’re considering buying a business, it’s important to consider all the risks that could be associated with a transaction. A few helpful questions for state and local tax matters that you can ask are:
- Is the company filing everywhere it needs to be filing?
- Are the filings being done correctly? (In addition to income tax, also consider sales and use tax, property tax, gross receipts tax and franchise tax.)
- Are there or have there been any state audits? If yes, what is the status?
- Does the company have refund claims outstanding?
Most companies tend to focus on income taxes, but in the context of a sale or purchase of a business, transaction taxes can have a significant impact. What are some things to consider with regard to transaction taxes?
It is important to be aware of the treatment by the state where the specific transaction occurs, as it relates to the particular type of deal. Because the tax laws vary by state, there are many other potential consequences depending on your company’s business presence.
For example, some states require you to only file notice of a bulk sale transaction, and others don’t. Some states will tax a bulk sale transaction, while others don’t.
It’s important to know the tax rules that apply to you so that you can comply with them effectively.
Once a deal is completed, what should buyers consider in regard to state and local tax?
There will always be an upcoming tax deadline, so when you’ve gone through a transaction, it’s important to anticipate those well in advance and adopt a plan of action to properly prepare for any post transaction deadlines, such as monthly sales tax filings.
Between the time when your transaction occurs and the next tax deadline, it’s important to determine:
- What data you will need from the seller to prepare your returns;
- How you will acquire the reports you need to file your tax return;
- Who will prepare and process the payments;
- What funds will be used (pre-transaction funds or post-transaction funds); and
- Who will manage any open audits or refunds still in process?
So what’s the bottom line regarding due diligence and state and local tax?
Each business and each transaction are different, and because tax laws vary by state, no two transactions are exactly alike.
The only way to formulate a truly effective due diligence strategy is to research and stay informed about the tax laws for the states in which the company has a business presence and the various tax types that apply to the specific type of transaction.