M&A and Sales Tax: The Hidden Exposure That Can Impact a Deal

Mergers and acquisitions involve many moving pieces. From financial due diligence and legal reviews to operational planning and integration strategy, buyers have a lot to evaluate before a deal closes. 

Sales tax should definitely be a part of that evaluation. 

Sales tax exposure can easily go unnoticed during the early stages of an acquisition, particularly when a company has operated across multiple states for years. Unreported nexus, taxability errors, filing gaps, and unpaid liabilities can accumulate over time, and potentially become the buyer's problem after the deal closes. 

What's at Stake?

Mergers and acquisitions can uncover significant hidden sales tax exposure.

During due diligence, buyers may discover that a company:

• Has sales tax nexus in states where it isn't registered
• Has made taxability errors
• Has gaps in its filing history and unpaid sales tax liabilities
• Doesn't have adequate exemption certificate documentation

These issues can have a direct impact on a transaction.

Sales tax liabilities can affect deal valuation, delay closing, require escrow arrangements, or, in some cases, jeopardize the transaction entirely.

Because sales tax exposure is often overlooked until late in the diligence process, it can become one of the most costly surprises uncovered during an acquisition.

Immediate Response Steps

Whether you're acquiring a company or preparing your business for a potential transaction, evaluating sales tax exposure early can help identify issues before they become obstacles.

1. Conduct a Sales Tax Due Diligence Review

A sales tax review should be part of the broader due diligence process.

Review the company's sales tax history, including state registrations, sales tax filings, audits, nexus footprint, exemption certificate management, product and service taxability determinations, etc.

The goal is to understand how the company has managed its sales tax obligations and identify potential gaps before the transaction moves too far forward.

2. Evaluate Nexus Exposure

A company's sales tax footprint may be broader than its registration footprint.

Analyze sales activity across all states to determine where economic or physical nexus may have been established but not addressed.

This is especially important for businesses that have experienced significant growth, operate across multiple states, or have employees, inventory, contractors, or other activities that may create physical nexus.

Identifying nexus exposure during due diligence can help buyers understand what obligations may need to be addressed as part of the transaction.

3. Review Product and Customer Taxability

Nexus is only part of the equation.

Confirm whether the company's products and services are taxable in each state where it has nexus.

It's also important to review exempt customers and make sure valid exemption documentation is on file.

Taxability errors or missing exemption certificates can create additional exposure that may not be immediately apparent from reviewing filings alone.

4. Assess Historical Liabilities

If potential exposure is identified, determine how far back the issue goes and quantify the potential liability.

This may include:

• Unpaid sales tax
• Penalties
• Interest
• Other related compliance costs

Understanding the potential liability early provides more flexibility to determine how the issue should be addressed before closing.

It can also give both parties a clearer picture of the financial implications of the exposure and help inform the transaction structure.

5. Explore Mitigation Options

Discovering sales tax exposure doesn't necessarily mean a deal has to fall apart.

Depending on the circumstances, there may be options for mitigating the risk.

Potential strategies can include:

• Voluntary Disclosure Agreements (VDAs) to address historical exposure
• Exemption certificate remediation to resolve documentation gaps
• Customer outreach, including "XYZ" letters
• Negotiated escrow arrangements to account for potential liabilities

The right approach will depend on the nature and extent of the exposure, but identifying these options early can provide more flexibility and help keep the transaction moving forward.

Don't Stop at Closing

Sales tax due diligence shouldn't end when the deal closes.

An acquisition can fundamentally change a company's sales tax footprint.

The combined business may have new states where it has nexus, additional products and services, new customers, different exemption certificate requirements, and new operational complexities.

That's why it's important to establish a clear post-acquisition sales tax compliance strategy.

This should include:

• Ongoing nexus monitoring
• Product and service taxability reviews
• Registration management
• Filing and remittance processes

The sooner these areas are evaluated after an acquisition, the easier it is to establish a compliance process that reflects the combined business.

Make Sales Tax Part of Your M&A Strategy

Sales tax may not be the first thing that comes to mind when evaluating an acquisition, but overlooking it can have significant consequences.

A thorough sales tax review can help uncover hidden liabilities, give buyers a clearer understanding of the target company's compliance position, and provide more time to address issues before they affect the transaction.

For sellers, proactively identifying and addressing sales tax exposure can also help prevent surprises during due diligence and make the business better prepared for a potential transaction.

Whether you're buying, selling, or integrating a business, sales tax deserves a place in the M&A process.

More Sales Tax Risks to Watch

Mergers and acquisitions are just one of the business events that can create unexpected sales tax exposure.

Throughout this series, we've looked at the different situations that can trigger sales tax risk, from audit notices and changes in sales tax personnel to sales growth, new employees and locations, and product or service expansion.

Want to know what to do when a sales tax problem finds you?

 Read the full Sales Tax Incident Response Kit for practical guidance on six common events that can trigger sales tax risk, along with immediate steps your business can take to assess exposure, address issues, and strengthen your compliance processes.