What CFOs Should Consider Before Closing a Deal: Potential SALT Pitfalls in M&A
Key Takeaways
- State and local tax (SALT) due diligence can identify M&A risks tied to transaction structure, successor liability, state conformity and historical tax positions.
- Buyers should assess nexus, apportionment, unclaimed property and indirect tax exposure, particularly as remote work and economic nexus expand state filing obligations.
- Partnership interest sourcing and pass-through entity tax (PTET) elections vary by state, making pre-closing analysis critical to managing exposure and preserving tax benefits.
Although federal tax considerations often drive the structure of an M&A transaction, state and local tax (SALT) issues can be just as significant because the state tax consequences may differ depending on the structure of the transaction, the states involved and the activities of the business.
Identifying these issues during due diligence allows buyers and sellers to evaluate potential exposures before they impact the transaction. Early identification can also allow planning opportunities to be implemented effectively.
Below are several key SALT considerations that should be evaluated pre-closing.
Asset Versus Stock Sale Considerations
In an asset acquisition, buyers should consider potential successor liability, sales and use tax, transfer taxes and other transaction-related taxes that may apply. Although buyers may limit the liabilities assumed in an asset transaction, certain state tax liabilities may follow the business. Many states have some form of successor liability, meaning a buyer can end up on the hook for a seller’s unpaid taxes even in an asset deal. The rules vary by state, and certain states impose bulk sale notification, tax clearance or other pre-closing requirements that should be addressed early in the transaction process to help limit potential successor liability.
By contrast, in a stock acquisition, buyers generally retain the target’s historical tax attributes and filing positions. However, a stock transaction does not eliminate state tax considerations. For example, an IRC Section 338(h)(10) election may result in a deemed asset sale for federal income tax purposes, but states may not always conform to the federal treatment. Similarly, reorganizations under IRC 368(a)(1)(F) should be considered for state conformity, reporting requirements and the treatment of tax attributes, including net operating losses, pass-through entity tax (PTET) elections and credits.
Unclaimed Property
Unclaimed property is frequently overlooked during transaction diligence, particularly in stock acquisitions where the liability generally remains with the target company. In states such as Delaware, companies that have never filed required unclaimed property reports may effectively have no statute of limitations. As such, historical exposure can become significant if compliance has not been properly evaluated before closing.
Nexus, Apportionment and Indirect Tax
An acquisition may create new filing obligations if the target has employees, inventory or property that establish nexus in states where the buyer previously had no filing requirements. Notably, the expansion of economic nexus standards post Wayfair has changed how businesses evaluate their state tax obligations. Physical presence is no longer the only factor considered when determining when a company has a filing requirement. As a result, state tax filing issues can often be a more important risk factor than federal income tax exposure.
As businesses continue to operate through digital platforms, remote employees and other technology-driven models, buyers should evaluate whether the target has established nexus through sales activity, customers, employees or other connections with states where the buyer previously had no filing requirements.
Of significant importance, Public Law 86-272 positions should also be reviewed as evolving business practices may impact whether certain protections continue to apply. This is also often a key diligence issue, as the rapidly evolving state and local tax landscape has led many sellers to be out of compliance. For both buyers and sellers, identifying the level of risk with previous filing positions is crucial.
In addition to income tax considerations, companies should account for indirect tax obligations, including sales and use taxes, gross receipts taxes, transfer taxes and other state-specific taxes. Certain industries may also be subject to specialized taxes, including telecommunications taxes, insurance premium taxes or financial institution taxes.
Partnership Interest Sourcing and PTET Elections
State taxation of partnership interest sales continues to vary among jurisdictions. Some states apply a look-through approach based on the partnership’s underlying assets or business activities, while others treat the transaction as the sale of an intangible asset. Understanding these differences before closing can help identify potential state tax exposure and mitigate risks.
Buyers should also evaluate PTET election considerations when a transaction closes during the tax year as states may have specific filing requirements, estimated payment obligations or deadlines. For sellers, PTET elections can provide a meaningful benefit by mitigating the impact of the federal limitation on the state and local tax deduction, particularly in asset sale transactions (including deemed asset sales in F reorganizations or with Section 338(h)(10) election).
Because PTET election requirements and deadlines vary by state, identifying these opportunities early can help preserve available tax benefits and avoid missed filing requirements.
A Pre-Closing SALT Review Should Focus on These Areas
- Transaction structure and whether federal elections have state tax implications.
- Historical nexus, filing positions, successor liability and unclaimed property compliance.
- Availability and limitations of state tax attributes.
- Sales and use tax, gross receipts tax and other indirect tax obligations.
- Industry-specific state tax considerations.
While federal tax considerations often receive the most attention in M&A transactions, SALT issues can materially affect purchase price, negotiations and post-closing obligations. Addressing these issues during due diligence allows buyers and sellers to identify potential exposures before closing and reduce the risk of unexpected state tax liabilities post-closing.
Contact Us
PKF O’Connor Davies regularly helps both buyers and sellers navigate the SALT issues in a range of transaction structures across industries. For assistance, contact your client service team or:
Denisse Moderski, CPA
Partner
dmoderski@pkfod.com | 646.699.2858