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.
But, state and local tax matters can get complex quickly based on a company’s footprint, where it is operating and the details of the transaction. What should you know in order to minimize your tax burden and be sure your company is in compliance with relevant regulations?
In this episode of The Wrap, state and local tax (SALT) experts Reba Pennington, CMI and Colleen Aldridge, CPA join Kim and Paul to discuss what businesses should consider when it comes to SALT when they’re looking to buy or sell.
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Intro (00:00) Welcome to The Wrap, a Warren Averett podcast for business leaders designed to help you access vital business information and trends when you need it so you can listen, learn and then get on with your day. Time is tight, that’s why our advisors have wrapped up today’s most timely topics into a podcast with actionable advice. Now let’s get down to business.
Paul (00:22) Hey, Kim.
Kim (00:23) Hey, Paul.
Paul (00:24) How are you today?
Kim (00:25) I’m great. How are you?
Paul (00:26) I’m doing good. Glad to be back for another podcast.
Kim (00:28) Me too, always good to be with you on these podcasts. And today is a fun topic. Most people might not describe it as fun, but I think it’s fun.
Paul (00:36) I think it’s always good to get information as it relates to businesses and what they need to be doing from different perspectives. Today we are going to be talking about state and local tax considerations during due diligence, whether you’re buying or selling a business. With us is Colleen Aldridge and Reba Pennington. Welcome.
Reba (00:56) Thank you.
Colleen (00:57) Thank you.
Paul (00:58) Glad you guys are here.
Kim (00:59) So the listeners may hear us refer to SALT, and we are not talking about salt and pepper, we are talking about state and local tax, SALT.
Paul (01:07) Thank you very much. I, as an auditor, needed that help, I appreciate it.
Kim (01:11) Sometimes we use acronyms. We love acronyms in CPA world. So we have to be very careful that we’re making sure people know what we’re talking about.
Paul (01:21) So Colleen and Reba, as we start this conversation, companies that are considering selling the business or buying a business, what is some of the due diligence as it relates to state and local tax? And why is it so important?
Colleen (01:34) Thanks, Paul. Due diligence is the process of identifying and analyzing the tax risk associated with acquiring a business or selling a business. If you think about it in the terms of selling a house, you wouldn’t put your house on the market without going in the back of that closet deep dark in your basement and checking out all the things in the boxes. And what do you have hiding underneath those blankets that have been sitting there for 20 years? Or what’s wrong with the roof? Or what’s wrong with your bathroom toilet that never flushes quite right? You would want to make sure that you’ve looked at all of the things that could potentially be a risk area from a state and local perspective in a due diligence transaction.
Kim (02:17) So there are federal, state, local tax issues in every transaction that need to be considered and most of time, the federal income tax often garners the most attention, but there are also state and local tax issues, so tell us about that.
Colleen (02:31) There’s one federal tax code, but when you look at the state and local area, you’ve got thousands of codes that you need to look at and multiple tax types. You’ve got property tax, sales and use tax, gross receipts taxes, income taxes, franchise taxes and they all have different rules, there are different jurisdictions that apply those taxes, and so it gets very complex very quickly, depending on the company’s footprint and where they’re operating.
Paul (02:58) So knowing the company’s footprint is important, knowing what you are doing in a certain region territory state is important, from the perspective?
Colleen (03:04) That’s correct.
Kim (03:05) So what are some of the factors of the transaction that can affect the state tax due diligence strategy?
Reba (03:12) I think the largest factor to look at is whether the transaction of the stock deal versus an asset sale, the time constraints that you have to perform the due diligence, what resources you have available and what’s the size and the purpose off the transaction?
Colleen (03:30) I agree, Reba. There’s also we need to look at the nature of the party’s respective businesses. If they’re in an industry like high tech, there are some unique issues that come up in the state and local area. When we’re talking about high tech businesses, you also need to look at the risk exposure and the tolerance level of the parties involved. If it’s a low dollar transaction and they just want to get the deal done, they just want to know where there any big issues, we’re not going to spend two weeks looking at this, we might spend 24 hours. If it’s a much bigger deal and there’s a lot of risk sensitivity involved, it may be a longer, more drawn out process. And as we mentioned before, the company’s footprint is very important. If they’re operating in the Southeast in three states, that’s going to be a heck of a lot easier than somebody that’s got a national footprint that may have significantly more issues and more taxes to be concerned with.
Paul (04:14) So what are some of the steps that sellers can do with respect to preparing for that potential sale?
Colleen (04:19) Preparing for a sale shouldn’t start at the date that the due diligence begins. In other words, back to the analogy about the house, if I’m going to put my house on the market, I’m not going to wait to the day the real estate agent sticks the sign in the front yard, I’m going to start preparing for that ahead of time and start looking at what are the things that potentially need to be fixed? What’s going to add value to my house? Same thing from a perspective of due diligence. I want to start cleaning my house 12 to 18 months ahead of time, if I can. We need to consider, you know, state tax reserves that we might have on our balance sheet. Are those sufficient? Are they overstated? Do we need to revise them to make them more realistic based on factors that have changed in time? Also investigating areas that might create exposure, like non filings and economic nexus. We want to make sure we’ve got a documentation of our state local tax audit history. Do we have state audits going on, and if we do, do we have an adequate log of what the status is on that so we know who’s responsible if a transaction does go through? Who’s going to help get this over the finish line?
Reba (05:19) Another thing we want to consider Colleen, is if we have taken steps to comply with the new tax law changes that have taken place recently. For sales and use tax, that’s the way fair case and then the federal tax reform.
Colleen (05:30) I agree.
Paul (05:31) So you both are very knowledgeable about state and local taxes. Why the passion? Why did you become such an expert?
Reba (05:37) I think for me, state and local tax, specifically sales tax, it’s relatable to everybody. Everybody knows what it is. We pay sales tax. We make purchases. It’s very much commonplace. When I became involved in taxes many years ago, I was surprised to find out that this is the largest revenue source in most state governments. The challenges associated with applying state taxes over 46 plus states has always been challenging, but it’s kept me on my toes.
Colleen (06:05) I feel the same way, Reba. For me, I started my career in federal tax and quickly took a turn towards state and local tax when an opportunity came available to help grow a practice. The challenge of so many different taxing jurisdictions and for federal tax, you know one way to do it and it either follows or doesn’t follow for state purposes. If it doesn’t follow federal than I have to look at the rules and figure out how it does need to be done for state purposes, so the challenge of that, ever-changing laws also. Every year there’s legislative sessions and the laws change with those legislative sessions. So the challenge to keep myself intellectually stimulated with the law change has been very rewarding for my career.
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Kim (06:56) So let’s change the conversation up a little bit and talk about this from a buyer’s perspective as it relates to state tax.
Colleen (07:02) The one key thing to take away is buyer beware. If you’re not careful and look at all the risk that could be associated with the transaction from a state and local perspective, you may get saddled with those after the transaction if you haven’t dealt with it in your purchase agreement. One of the big things that you have to look at from a filing perspective is, is the company filing everywhere it needs to be filing? That covers not just income tax, but also sales and use tax, property tax, gross receipts tax, which are often overlooked and franchise taxes. So there’s multiple tax types that have to be considered to make sure everything is filed correctly. The next perspective is if those filings are being done, are they being done correctly? Are there exposure items in the return that we need to account for as part of the purchase transaction?
Reba (07:46) And just to reemphasize something you mentioned earlier Colleen, you need to determine if the company is under audit by any jurisdictions and what the status of those audits are. If they have refund claims outstanding, what the status of those are. You want the documentation in place going forward to ensure that all liabilities and refunds are handled properly.
Paul (08:08) I’m not really up to speed that there could be transaction tax consequences outside of income taxes, what might those be? And how do you avoid those?
Reba (08:15) Well, every transfer of tangible personal property is potentially subject to sales and use tax, unless there’s a specific exemption that applies. So state and local taxes or sales and use taxes generally don’t follow the state federal or the income tax treatments. While a stock deal or a stock transaction may not be subject to tax, an asset deal or an asset transaction may be subject to sales and use tax. There are lots of considerations that need to be taken under advisement. Some states require you to file notice of a book sale transaction. Some states will tax a book sale transaction. Some states don’t. So you need to be aware of how the specific state where the transaction occurs treats that particular type of deal. You also want to look at any leases, any other exemptions or inclusions that could be considered from state to state. The challenge is just to know where the transaction’s taking place and what rules apply.
Colleen (09:12) I agree, Reba. Also looking at exemptions that are available, there are some broad categories of exemptions, like isolated or occasional sales, which means we’re not in the trade or business of selling our assets everyday that we use to generate income. Because of that, we may be eligible for an exemption that says, “If I only do this once in a lifetime or once every couple of years, I don’t have to pay sales tax on that transfer.” We also have for inventory purposes, “We’re not the trade or business of selling our inventory to another person as part of a sale of a business, but would have to look to see if there’s a sale for resale exemption that would apply to selling my inventory as part of this transaction.” Additionally, there may be exemptions for manufacturing machinery equipment that may apply to certain industries over others. As Reba said, it’s also going to vary state by state as to which exemptions are available. Usually the sale of vehicles and the sale of real estate will be excluded from any of those exemptions, so you have to look to see if they’re going to be taxes particularly related to the sale of vehicles. If I’m selling a company that has a fleet of vehicles that could be a huge dollar consideration as part of the transaction. If I’ve got one service vehicle that belongs to the owner, maybe not so much.
Kim (10:22) So once due diligence is completed, are there any post transaction state and local tax issues that need to be addressed?
Colleen (10:30) This is a key responsibility because, as in for tax purposes, deadlines don’t change. There’s always going to be a tax deadline going on and when you’ve got a transaction and it happens very quickly, you’ve got a lot of confusion in your first 30 to 60/90 days and need to agree on responsibilities up front as to how things were going be handled. How am I going to get my reports to do my tax returns? I’ve got a sales tax return due on the 20th of the month, potentially for multiple states. How am I going to get those done? Who’s going to have the responsibility? What reports am I going to use to be able to do that? Who’s going to cut the checks? Who’s going to prepare the check requests? Are those funds going to come out of post transaction funds or are they pre transaction funds because it’s filed in arrears? Coming to agreements on things like that is huge. Getting a plan in place for this, plus other things, it’s going to make that 1st 90 days go much smoother. Same thing for income tax. We talked about sales and use tax, but for income tax, I’ve got short period returns that are potentially due. How are we going to split the short period returned? Is the seller going to prepare the first short period and the buyer second short period? Which accounting firm are they going to use to prepare those things? So there is a lot of things that need to come together in a short period of time related to deadlines that don’t move just because I did a transaction today versus two months ago versus the year from now.
Reba (11:50) Some other considerations would be who’s going to take over any audits or refunds that are open? We mentioned those before, but it’s important not to let those fall through the cracks. We also want to have an indemnification clause in the purchase agreement. Is the seller going to indemnify the new owner for any liabilities? Who gets the refunds if money is found to be owed back to the taxpayer of the client? These are all things that need to be talked about and settled in the buyer purchase agreement. There also could be remediation strategies that are being in place under the due diligence process. It may be determined that the taxpayer of the client hasn’t met all their obligations for filing, and so they may have entered into some voluntary disclosure agreements or some agreements with the states to basically come clean. We want to know who’s going to handle those and who will sign off on those? You could have a successor liability, this is something that’s going to follow the buyer unless they take care of it in the buyer sell agreement. So you want to just take into consideration if you’re the buyer, what are the pitfalls? What could I be on the hook for and make sure you’ve covered all those.
Kim (13:00) All right, so here on The Wrap, we always like to wrap it up in 60 seconds or less so how would you summarize the takeaways on state tax due diligence for our podcast listeners?
Reba (13:09) I think the takeaway is you can structure a deal to minimize your taxes if you really try, the potential is there. Take advantage of your planning opportunities. Make sure that your house is clean, it’s in order and when it comes time to make that transaction happen, you won’t be burning the midnight oil to make sure everything is in order.
Colleen (13.32) From a seller perspective, time is your enemy in a deal. You don’t want to wait until the last minute to start thinking about your issues or start dealing with it because any exposure calculations that are come up with during a due diligence process are certainly going to be more favorable to the buyer, not to the seller. You want to own the issues, get out in front of it, come up with your own estimate and present that as part of the due diligence process. Don’t wait for somebody to do it for you because you’re never going to win in that situation.
Kim (14:00) It sounds like planning, knowing what you’re dealing with and being proactive seems to be kind of the key theme that I’ve heard throughout this podcast. As you said, there’s a lot of different rules and systems to go through so you probably need an expert to help you walk through that. We appreciate both of you being here and sharing your knowledge and expertise with our listeners. Thank you very much.
Paul (14:27) Thank you guys.
Colleen (14:28) Thank you.
Reba (14:29) Thank you.
Close (14:30) And that’s a Wrap. If you’re enjoying the podcast, please leave a review on your streaming platform. To check out more episodes, subscribe to our podcast series or make a suggestion for other topics to cover, visit us at warrenaverett.com/thewrap
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