When businesses embark on mergers or acquisitions (M&A), executives and dealmakers naturally prioritize financial forecasts, efficiency gains, and strategic advantages such as market share or new product offerings. While these are critical to the success of a transaction, one area is too often overlooked: sales and use tax compliance. Failing to evaluate this element of due diligence properly can expose both buyers and sellers to unexpected liabilities, diminished deal value, and post-closing disputes.
Sales and use tax issues may not command the same headlines as revenue growth or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) multiples, but they carry real financial consequences. Identifying these risks early in the process enables stakeholders to preserve deal value, strengthen their negotiating positions, and ensure a smoother integration following the transaction’s closure.
Why Sales and Use Tax Matters in M&A
Sales and use tax compliance is rarely straightforward. It is governed by a patchwork of state and local rules that change frequently, often with little warning. Even companies with strong accounting teams can unknowingly create exposure through minor missteps, such as missed filing deadlines, misapplied exemptions, or misinterpretations of taxability rules.
One of the most important considerations for buyers is that sales and use tax liabilities typically “follow the business.” In other words, when a company is acquired, the buyer generally assumes responsibility for existing and historical tax obligations. If these liabilities are not correctly identified during due diligence, the buyer may incur substantial costs long after the purchase agreement is signed. This is why sales and use tax must be treated as a core component of the risk assessment process, not as an afterthought.
Common Sales and Use Tax Risks in M&A
While the specific risks vary by industry and jurisdiction, several recurring themes tend to surface during M&A reviews:
1. Unreported Nexus Exposure
Since the South Dakota v. Wayfair, Inc. decision in 2018, states have increasingly enforced “economic nexus” laws that require businesses to register and collect sales tax based on sales volume or transaction count, even in the absence of physical presence. Many companies underestimate their nexus footprint, especially if they sell across multiple states. Failing to register can result in years of unpaid liabilities, as well as penalties and interest.
2. Invalid or Missing Exemption Certificates
Resellers and tax-exempt customers often purchase goods without paying sales tax; however, businesses must collect and maintain valid exemption certificates to justify these non-taxed sales. Missing, expired, or improperly completed certificates can result in substantial assessments during an audit. In an M&A transaction, buyers inheriting poor exemption management practices face the risk of costly “surprise” tax bills.
3. Incorrect Taxability Determinations
Not all products and services are taxed uniformly across jurisdictions. A service considered exempt in one state may be taxable in another. Software, SaaS, digital goods, and professional services are especially complex. Misclassifications may result in under-collected sales tax that can snowball into material liabilities.
4. Historical Audit Assessments
Any pending or unresolved audits transfer to the buyer along with the business. These can involve not only unpaid taxes but also significant penalties and interest. Without a clear understanding of audit history, a buyer may be stepping into a financial minefield.
5. Use Tax Compliance Gaps
While most attention is focused on sales tax, use tax compliance is equally critical. Businesses are required to self-assess use tax on taxable purchases where sales tax was not collected, such as purchases from out-of-state vendors. Many companies overlook this obligation, leaving behind liabilities that remain invisible until surfaced by an auditor or a diligent buyer.
Best Practices for Buyers
Buyers who want to protect their investment and negotiate from a position of strength should integrate sales and use tax reviews into their broader due diligence process. Recommended steps include:
- Conduct a Sales and Use Tax Review Early: Don’t wait until the final stages of the deal. Request detailed filing histories, nexus analyses, and compliance records early in due diligence.
- Assess Nexus and Registration Status: Confirm where the target company has nexus and whether it is registered in those jurisdictions.
- Review Exemption Certificate Management: Evaluate whether exemption certificates are current, valid, and securely stored.
- Examine Audit and Notice History: Understand whether there are ongoing audits, historical assessments, or disputes with taxing authorities.
- Quantify Potential Exposure: Where risks are identified, estimate potential liabilities and use that information to negotiate purchase price adjustments or indemnification provisions.
Best Practices for Sellers
Sellers also stand to benefit from proactively addressing sales and use tax. A clean compliance record can increase company value and reduce the likelihood of last-minute deal complications. Practical steps include:
- Proactively Address Compliance Gaps: Resolve nexus exposure, file outstanding returns, and update exemption certificates before engaging in M&A discussions.
- Be Transparent: Provide buyers with complete and accurate sales tax records. Transparency not only reduces risk but also fosters buyer confidence in the business’s integrity.
By positioning themselves as tax-compliant, sellers can enhance their negotiating leverage and mitigate the risk of value erosion at the closing table.
Sales and Use Tax Considerations are Essential to a Smooth Transaction
Sales and use tax compliance should never be treated as an afterthought in mergers or acquisitions. Overlooked liabilities can derail negotiations, reduce a company’s value, and create significant post-closing risks for both buyers and sellers. Incorporating a thorough tax compliance review into due diligence ensures stronger valuations, fewer surprises, and greater long-term success for all parties involved.
Your Trusted Sales and Use Tax Advisors
Don’t let hidden sales tax risks derail your deal. At Thompson Tax, we specialize in uncovering liabilities, resolving compliance gaps, and supporting businesses through the complexities of mergers and acquisitions. Whether you are a buyer seeking to protect your investment or a seller aiming to present a clean bill of compliance, our experienced advisors provide clarity, confidence, and peace of mind.
Partner with us to safeguard your next transaction. With Thompson Tax by your side, you can move forward knowing that your investment is protected, your risks are addressed, and your business is positioned for long-term success. Contact us today to ensure your next merger or acquisition achieves its full potential.