Benefits of a post-transaction state & local tax profile evaluation
Many acquirers focus some due diligence efforts on evaluating whether the target has complied with all pre-acquisition state and local tax obligations. In the heat of the deal, however, they’re often not as focused on non-exposure matters, such as how the deal impacts their post-acquisition state and local taxes. The type of acquiring entity (C corporation, partnership, etc.) and the type of acquisition — assets vs. purchasing an interest in the target entity — often affect a buyer’s future state and local taxes in some manner. Further, not all state and local taxes are necessarily impacted in the same way. Soon after the dust settles from closing the transaction, the acquirer should consider engaging a professional to perform a post-transaction profile evaluation to ensure compliance with its state and local tax filing obligations.
As the dust settles from a new acquisition, a post-transaction SALT profile evaluation can ensure compliance with state and local tax rules.
Nexus for filing obligations
A post-transaction profile evaluation should assess where state and local tax filing obligations may exist (nexus), since the acquisition may require the buyer to file in additional jurisdictions. A due diligence report that addresses nexus should help in evaluating where such additional filings may be required. Filing tax returns in all the required jurisdictions prevents costly and time-consuming problems down the road, including avoiding penalties and interest from underpaying tax and mitigating business risks, such as being precluded from doing work with governmental agencies that require the company to certify that it’s filed and paid all state taxes. Further, there are no statute of limitations for returns that haven’t been filed where required; thus, a taxing jurisdiction could assess tax, interest, and penalties at any time.
The type of acquisition substantially impacts where the buyer has nexus in post-acquisition periods. For instance, if Corporation A, a C corporation that filed state tax returns solely in Illinois, acquired the assets of Target Z, which filed only in New Jersey, then Corporation A would be required to file state tax returns in New Jersey. However, Corporation A would not be required to file in New Jersey if it had instead acquired the stock of Target Z.
Post-acquisition nexus is also determined by the acquisition structure and may be different between types of tax. For example, in most states, acquiring an interest in a partnership will create net income and net worth tax nexus for each partner. However, nexus is less likely to occur for other types of state and local taxes, such as sales, use, and payroll taxes.
Income tax filing methods
In addition to nexus, a buyer should evaluate the impact of an acquisition upon its net income taxes, including its filing methods and elections. For example, approximately 25 states require commonly owned C corporations to file on a consolidated basis if they have a “unitary” relationship, which is generally shown where the corporations are sufficiently interdependent, integrated, and interrelated through their activities. Further, some states apply the unitary relationship criteria in determining how a partner will compute its tax on partnership income. A buyer will likely find factors for and against the existence of a unitary relationship, especially in the year of acquisition, which may provide an opportunity to file income tax returns in the most advantageous manner.
Unused tax attributes
The buyer should also evaluate whether it is a successor to any, or all, of the target’s state net operating losses, and, if yes, determine if there are any limitations on the use of them, such as Section 382 of the Internal Revenue Code. Another area is the buyer’s ability to retain the target’s pre-acquisition credits and incentives. This assessment should include evaluating the requirements to retain the credits and incentives and corresponding clawbacks, especially if the buyer is considering changing operations (such as reducing workforce). In some states, the taxing authority or economic development authority is required to be notified of a sale and may require the state’s approval prior to close in order for the credit or incentive to survive post-acquisition. As such, any credits and incentives should be reviewed well before closing.
Sales/use and transfer taxes
In addition to net income taxes, there are many post-acquisition sales/use and transfer tax issues to consider. For one, the buyer should determine if the acquisition itself is subject to sales/use tax or some other type of transfer tax. The type of acquisition and operations acquired will generally dictate the sales/use and transfer tax treatment. For example, sales/use tax often doesn’t apply to the purchase of an interest in a legal entity, while real estate transfer taxes could. If the acquisition is found to be taxable, then the buyer should consult the purchase agreement to determine if it’s responsible for filing and paying such taxes to ensure taxes due are timely paid.
The buyer also should evaluate whether the acquisition has changed the taxability of its sales and purchases in the states it has nexus, and update its corresponding policies accordingly. Other post-transaction sales/use tax considerations should also include determining whether updated exemption certificates are required. This is likely not an issue with respect to acquisitions of an interest in a target entity but could be with asset acquisitions and certain types of mergers.
The acquirer should also review the impact on its unemployment taxes. Typically, the unemployment tax rates and benefits paid history will follow the group of employees. However, the absorption of a significant number of new employees from a target company will usually have an impact on unemployment tax rates applicable to all employees, including those employed prior to the transaction.
Lastly, the post-transaction profile evaluation should include assessing and updating the effective state income tax rate, ASC 740-10 (formerly FIN 48) and FAS 5 reserves, and valuation allowances for purposes of reporting taxes on post-acquisition financial statements.
Assessing whether a buyer is a successor to a target’s historical state and local tax exposure is an important part of any acquisition. However, a buyer should be aware that an acquisition, regardless of size, can significantly impact its overall state and local tax profile. With so many diverse tax rules among state and local jurisdictions, a post–transaction state and local tax profile evaluation is essential to ensure tax compliance and avoid unforeseen tax risks and liabilities.