Blog

How tax diligence, deal structure, and the right advisory team protect deal value for buyers and sellers

Why Tax Planning Drives Positive M&A Outcomes

While purchase price and multiples can dominate early M&A discussions, tax implications can have a meaningful impact to the actual net proceeds for sellers and the true acquisition cost for buyers. Poor tax planning can lead to unexpected liabilities, reduced valuations, and can even terminate a deal.

Tax Due Diligence Essentials

When taxes come to mind, it often revolves around tax compliance and ensuring you are meeting your filing obligations each year. While this may be the standard focus, an involved advisor and detailed tax advisory plan should be addressing items that could be points of contention during tax due diligence. Thorough tax due diligence identifies and quantifies risks that affect pricing, structure, and post-closing obligations. Key areas include:

• Federal Income Tax Positions: Filed returns, NOL and Credit Carryforwards, Pending IRS Disputes

• State and Local Tax (SALT) Compliance: Nexus Analysis, Apportionment, and Outstanding Liabilities

• Sales and Use Tax Exposure: Collection Practices, Exemption Certificates, and Successor Liability

• Employment Tax: Worker Classification and Withholding Compliance

• International Considerations: Transfer Pricing, GILTI, FDII, and Foreign Tax Credits

• At-risk Positions: Uncertain Tax Positions under ASC 740 and IRC Section 382 NOL Limitations

State Tax Nexus: A Major Source of Deal Risk

Since the 2018 Wayfair decision eliminated the physical-presence requirement for sales tax nexus, nearly every sales-tax state has adopted economic nexus rules, which are typically triggered at $100,000 in annual in-state sales. At least 16 states have extended economic nexus to income and franchise taxes as well.

Unfiled state returns are especially dangerous in M&A. Statutes of limitation generally do not start running until a return is filed, meaning liabilities from five or ten years ago may still be open. In equity deals, these obligations pass directly to the buyer. Even in asset deals, many states impose successor liability. When an issue like this is identified, it often results in reduced considerations and expensive corrective measures, and even holdbacks for tax liabilities.

Common SALT Findings in Diligence

• Unfiled returns in nexus states, especially for SaaS, e-commerce, and tech companies

• Incorrect apportionment methodologies (market-based vs. cost-of-performance sourcing)

• Unclear sales tax treatment of SaaS and digital products, which varies widely by state

• Missing exemption certificates exposing the target to uncollected sales tax liability

Mitigating SALT Exposure

Voluntary disclosure agreements (VDAs) allow sellers to resolve unfiled returns with reduced lookback periods and abated penalties. Purchase agreements should include indemnification provisions and escrow accounts for pre-acquisition liabilities. Buyers should plan for post-closing re-registration and exemption certificate consolidation.

Deal Structure: Asset vs. Equity Transactions

Buyers generally prefer asset purchases for the stepped-up tax basis, allowing depreciation and amortization that reduces future taxable income. C corporation sellers typically prefer equity sales to avoid double taxation. For pass-through entities (S corps, partnerships, LLCs), sellers may be more amenable to asset sales since pass-through treatment avoids double tax, although an asset sale may require apportionment amongst the states in which the entity does business.

Section 338(h)(10) and Section 336(e) elections can bridge the gap for S corporation targets, treating a stock purchase as an asset purchase for tax purposes. F-reorganizations under IRC Section 368(a)(1)(F) have also become a popular pre-transaction tool, preserving tax attributes and enabling installment sale treatment.

Pass-Through Entity Tax (PTET) Elections

Following the SALT deduction cap (now $40,000 under the OBBBA through 2029), nearly every state offers PTET elections allowing partnerships and S corps to pay state income tax at the entity level. Making a PTET election can materially affect after-tax proceeds for sellers operating through pass-through entities, but rules vary significantly by state.

QSBS Considerations

The OBBBA expanded the Section 1202 QSBS incentive with a tiered exclusion schedule, a $15 million per-issuer cap, and a $75 million gross asset threshold. Whether target stock qualifies as QSBS can dramatically impact seller after-tax proceeds. QSBS status should be evaluated carefully during diligence, and it is important to keep in mind that not all states mirror the Federal provisions. 

Assembling the Right Advisory Team

Successful M&A tax planning requires a coordinated, multidisciplinary team that should include M&A-specialized tax advisors, SALT specialists, experienced M&A counsel, valuation professionals, and financial advisors. Engaging this team early (even before an exit is on the horizon) allows tax issues to be identified before they become deal-breakers.

Key Takeaway

Tax implications are too significant to treat as an M&A afterthought. Thorough diligence, thoughtful structuring, and expert guidance are essential for protecting deal value on both sides of the transaction. 

Our team of experts is ready to help you through your business journey, and to help prepare you for a successful exit.