Due diligence and state taxes: What you don’t know can hurt you
All businesses should regularly review state and local tax obligations as part of their annual budget cycle. However, it’s particularly critical that a business preparing for a merger or acquisition carefully analyzes its state and local exposures and remedies any compliance issues. A thorough pre-transaction analysis can help to eliminate surprises and allow the seller to correct deficiencies wherever possible. Even if the seller is unable or unwilling to remedy a possible deficiency, it’s still important to be aware of the potential issue at the start of any negotiations rather than face an adjustment to purchase price or escrow after the buyer’s due diligence.
Four components of a SALT review
A complete review of state and local obligations has to cover a lot of ground. For each state, there are four key considerations to examine:
Most state tax obligations arise out of some type of presence, or “nexus” within the state. A proper review should document the potential existence of nexus and the presence or activity that supports the conclusion reached with respect to multiple taxes, including:
- Income tax
- Franchise tax
- Gross receipts tax
- Personal and real property tax
- Sales and use tax
In those states where nexus exists, the next step is to determine how much of a business’s income is subject to tax in that jurisdiction. Each state’s approach to apportionment varies with respect to the factors employed and the sourcing methodology applied. The various approaches can lead to significantly different amounts of state taxes due.
- Group filing requirements
Generally, states will either allow or require affiliated groups to file on a separate company basis or on a group basis. There are many nuances to group filings that must be considered, including which entities are considered affiliated and the method of calculating the tax base and apportionment. Most group filings relate to entities with a federal C corporation classification; however, there are certain group filings that apply to pass-through entities as well. Due to the group filing requirements, there may be certain entities drawn into filing in a particular state based on the presence and activities of another entity within the affiliated group. In addition, ownership of a pass-through entity may give rise to an income tax obligation for the owner that hadn’t previously been considered. Therefore, a taxpayer should not only consider its own presence and activities but also the presence and activities of related entities.
- Sales tax
At a high level, an entity should perform an analysis and document the taxability of sales, the taxable use of purchases, and the collection and maintenance of sales tax exemption certificates. In addition to performing these analyses, the entity should also confirm that its internal policies and procedures are consistently applied with respect to conclusions of taxability.
The Plante Moran SALT report card
Plante Moran’s SALT report card documents the results of an analysis that evaluates potential nexus issues and tax exposure in jurisdictions around the country. Whether it’s part of the seller’s due diligence before a sale, or part of the annual tax and budgeting process, the SALT Report Card can save businesses money and help them plan more effectively. It identifies jurisdictions where filings may become required in the near future even though current activities haven’t crossed filing thresholds. In some cases, the review may identify an obligation in a jurisdiction where the business should have been filing previously. States and local jurisdictions often have voluntary disclosure programs that can reduce penalties and limit a state’s ability to look back at prior returns when a taxpayer comes forward before being contacted about the deficiency. These programs can significantly lower the cost to the business of failing to comply.