While many entrepreneurs focus on the federal tax implications of a business sale, it's crucial not to overlook the state and local tax considerations that can have a substantial impact on the outcome of the deal. In this blog post, we'll provide an overview of state and local tax considerations when selling a business and steps that can be taken to prepare for a sale.
Why You Shouldn’t Overlook State and Local Taxes When Selling Your Business
The sale of a business can be stressful enough without having to deal with unknown or unexpected liabilities. Too often we see businesses dealing with matters such as income and non-income tax nexus, classification and taxation of products and or services, and transfer taxes. The landscape of state taxation is changing rapidly, and it can be difficult to keep up with when you are focused on operating the business. However, it is the job of the due diligence team to uncover and identify state tax exposures that the business has not considered. Often this process places the business and its owners in a defensive position to argue that these exposures are not material and should not result in an escrow or purchase price reduction.
Implement an Annual State and Local Tax Review
To minimize disruption that can result from the discovery of non-compliance with state taxes, your business should proactively seek to review business activity annually to determine if it has new filing responsibilities. Regardless of whether you choose to pursue any newly identified state tax filing requirements, you will have the information available to explain that you have undertaken a process to determine your filing responsibilities and the reasoning behind why you have not filled. Your ability to provide this documentation is a springboard for a more productive discussion related to the reasonableness of your filing positions.
Areas of taxation that should be analyzed on a regular basis encompass income and non-income taxes, including sales and use tax, payroll taxes, and unclaimed property.
When examining nexus for income tax purposes, it is important to look at what you are doing, where you are doing it, and how it is getting done. It is not only important to look at where things are being done physically but to also look at the role technology plays in your business’s ability to serve customers from remote locations. Also examine the role technology plays in your ability to solicit business from customers.
Sales tax is another area that should not be underestimated when it comes to due diligence during a transaction. There are many areas within sales tax that can trap a business that has not kept up with the tax laws. Nexus, valid tax exemption certificates, and the taxability of products and services are among the areas of consideration that should be addressed regularly.
State and Local Tax Considerations When Selling Your Business
- State apportionment and the inclusion of gross or net proceeds in the receipts factor
- Whether the sale involves the transfer of tangible assets such as inventory or equipment; some states may subject the transfer to sales tax
- Certain states impose transfer taxes on real property sales or the transfer of business entities. These taxes can vary significantly, and they may be based on the purchase price or the value of the property being transferred
- In addition to income and sales taxes, state and local governments may levy various business-related taxes, such as franchise taxes, business privilege taxes, or gross receipts taxes
- The state of residency at the time of the sale can influence your state tax liability. Some states have strict "domicile" tests to determine whether you're subject to their income tax laws. Careful planning is critical when reviewing potential tax considerations related to state residency, as this is a highly scrutinized area
It is important to remember that state and local tax considerations can vary widely from one jurisdiction to another, and they are subject to change. Proper timing and attention to the considerations mentioned above can help your business proactively plan for a sale and provide options and opportunities for resolution of issues that might be discovered to reduce or eliminate risks that could ultimately affect the outcome of the deal.