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Indirect Taxes π - a Due Diligence Nightmare
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There are a handful of areas in the tax world that business owners usually push the envelope on. One of them is "what states do we have to file in?" And while the answer isn't always clear at first, it is pretty black and white with enough research. π· This same bent usually also gets applied to indirect taxes - like sales tax, use tax, and excise tax. While growing, business owners want to file in as little jurisdictions and pay as little indirect tax as possible - even if it means they're in the grey. But this always changes when the buy-side due diligence list comes across. Buyers (and their advisors) know that exposure can often hang over the heads of the business (and assets) for years - creating the need for a higher hold-back, reserve, or escrow. And in severe cases, an aggressive level of noncompliance can kill deals. β°οΈ Today, we're going to get through three common types of taxes that cause this kind of pain when selling:
Let's dig in. β State Income TaxI'm a federal pass-through guy. So anytime a conversation branches into state issues, I always caveat the conversation with what I'll say here: when in doubt, pay for a good state nexus study. This can cost $20k-$30k depending on what states you work in and around - but can save you millions in due diligence findings. A nexus study is performed by qualified state tax experts that are far more familiar with the rules across the country. πΊοΈ The problem with state income taxes (besides it being theft - only kidding) is that the rules vary across states. Different states have different rules on what constitutes income "earned" in that state - and even what kinds of tax they can levy (business tax, privilege tax, franchise tax). And heaven forbid you decide to do any business in California. π» As inefficient as they are on development, they make up for it in their ability to identify an LLC that even thinks about doing in business there. This variance in rules is a nightmare for sellers but a dream for buyers looking for skeletons π©» and hidden liabilities. β Sales TaxAkin to the State Income Tax comments above, sales tax rules vary even wilder. And after the 2018 landmark case, South Dakota v. Wayfair, it was open season on drop-shippers and unreported sales tax. π But even if you don't ship across state lines, it is a challenge enough to decipher your own state rules on taxable activities. State websites list legalese and many times unhelpful FAQs to the wide array of industries and service providers. Unfortunately for sellers, the people who do know these rules well are usually on the buy-side. National firms have entire departments devoted to (a) defending their clients in audits, (b) selling nexus studies, and (c) blowing up deals for incorrect or unreported sales tax reports. π£ β Excise TaxThis is a trigger word for me. One of my largest clients at a previous firm had several run-ins with their excise tax liabilities because of what they did. It was also the cause of the largest IRS notice I've ever seen (which was also abated) - $30 million before interest. π€ The excise tax rules are old. And the IRS has specialists that work with them - who are not always adept at common sense solutions. Excise taxes are most common in fuel distributors β½, alcohol and tobacco sales π₯, and other random industries βοΈ. They require strict deadlines for reporting and payment - and the penalties rack up quick. For example, my client was an exporter of fuel (to a related party in another country). They were entitled to an excise tax export credit - which would have netted their liability to $0. They spoke with an IRS agent who advised them they didn't need to file excise tax returns because no amount was due. That was wrong. Three quarters later they were advised to file those Forms 720 late and claim the credit. The problem is the credit is only available on timely filed returns. They were hit with penalties for those late quarters for every gallon of fuel they exported. I'll save how we navigated it for another time. π β These state and indirect taxes can cause serious headaches for sellers who were previously okay with being aggressive. Good buy-side due diligence teams send all these reports to their internal team to shred them for missing or incorrectly filed returns. The best advice is to get a study done by a reputable firm years before you take your business to market. π«‘ π₯ Hottest Finance Posts This Week π₯
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