State tax issues often surface late in the M&A process—and can lead to complex renegotiations.
One of the most common culprits? An overlooked multistate tax obligation. These issues typically stem from undiagnosed nexus exposures, where the target company has created state tax liabilities without realizing it.
There are examples of this across all kinds of industries. The software company that never collected sales tax on its SaaS subscriptions in Arizona and Washington. The e-commerce business shipping orders to all fifty states while filing returns in only one. These scenarios represent real compliance gaps with material financial consequences.
Since the landmark Wayfair decision in 2018, state tax authorities have aggressively expanded enforcement efforts, creating a minefield for unprepared businesses and their potential acquirers. Many middle-market companies simply haven’t kept pace with rapidly evolving nexus and taxability rules. For dealmakers, the challenge is twofold: quantifying historical exposure that wasn’t built into valuation models, and determining how this risk should be allocated between buyer and seller.
State tax nexus issues are among the most common—and costly—surprises that emerge during M&A due diligence. From sales tax exposure to overlooked filing obligations, these risks can materially impact deal structure, valuation, and timing. Below, we’ve summarized the key nexus-related issues that consistently disrupt transactions.
Sales tax issues are one of the most frequent exposures encountered in transactions. The challenge has two components: determining where nexus exists and analyzing which products and services are taxable.
Post-Wayfair economic nexus standards have created complex compliance requirements that many companies either don’t prioritize or misunderstand until due diligence reveals the exposure. For many targets, especially smaller companies with few internal tax resources, sales tax obligations are often overlooked or inadequately analyzed.
We’ve advised on transactions where target companies have found that undiagnosed sales tax nexus issues alone can create exposure reaching seven figures in tax liability, plus penalties and interest. For mid-market transactions, tax liabilities of this magnitude significantly impact deal economics.
Beyond nexus determination, many companies incorrectly assess whether their products or services are taxable. States change their laws regularly, and it’s become a trend for states to make digital products and SaaS solutions taxable as they strive for more revenue from the digital economy.
This is particularly problematic for technology companies that assume their digital products or services are exempt from sales tax. There’s a persistent misunderstanding that only physical products create sales tax obligations. However, a number of states now tax SaaS, digital products, and downloadable prewritten software as these represent easy revenue sources for state governments.
Companies offering platform-as-a-service (PaaS) and infrastructure-as-a-service (IaaS) face similar challenges, with states increasingly applying sales tax to these offerings as well.
While sales tax issues are the most common, income tax nexus often presents even more complex challenges. Income tax rules vary significantly across states—particularly in how sales are sourced and income is apportioned. Some states use market-based sourcing, attributing income to where customers are located, while others rely on cost-of-performance rules, focusing on where the underlying activity occurs. This variation makes accurate nexus assessment far more nuanced.
Many companies overlook rules like the Finnegan Rule (named after a CA court case), where if one company in a unitary group has nexus in a state, sales attributable to that state from other entities in the unitary group can be included in the sales factor for purposes of apportionment. That means a single connection to a state can exponentially increase the tax liability for the group since multiple entities would factor into the calculation.
Sellers are often surprised by state-level taxes that fall outside traditional income tax frameworks, or where there would be an expectation of protection under P.L. 86-272. Gross receipts taxes (like those in Ohio and Washington), margin taxes (such as in Texas), and franchise or net worth taxes can all create meaningful liabilities—even for companies that are unprofitable.
Because these taxes can apply regardless of whether a company is incurring losses, they’re frequently missed until late in the deal process. Without a full understanding of their multistate footprint and exposure, sellers risk underestimating their tax exposures.
State tax nexus problems consistently emerge during due diligence. There are several reasons for this: the seller may still need to collect information, finds that it does not have the information, or may just be trying to stonewall the buyer on this topic.
The significance of these issues varies by transaction structure: stock deals face greater scrutiny than asset deals, though successor liability can still transfer certain tax obligations to buyers in an asset sale. Most target companies do not seek the help needed to sufficiently identify and address complex multi-state tax obligations before due diligence begins. With each state having unique standards and requirements, comprehensive assessment requires expertise and resources that most companies don’t possess internally.
Many sellers operate with a false sense of security based on limited analyses or outdated understandings of nexus requirements. When these issues emerge late in the process, they alter negotiation dynamics, giving buyers additional leverage to demand stricter terms and more extensive indemnification provisions.
For sellers caught unprepared, the opportunity for controlled remediation has already passed, shifting the focus from proactive problem-solving to reactive negotiation under less favorable conditions.
When state tax nexus issues surface during due diligence, they materially affect transaction economics and structure in several ways.
Discovered compliance gaps inevitably lead to expanded indemnification provisions and escrow requirements. Unaddressed nexus issues can lead to purchase price adjustments, particularly when exposures are significant. This also may affect representations and warranties insurance coverage if part of the transaction, with buyers pushing for specific tax-related protections with longer survival periods.
Though these issues rarely terminate deals completely, they do shift negotiation leverage. When diligence teams uncover significant exposure, buyers gain additional leverage to impose stricter negotiated tax terms. These discoveries also shift the psychology of due diligence from collaborative negotiation to defensive positioning, with acquirers posing additional questions about what other issues might exist. Even when the purchase price remains stable, remediation costs through voluntary disclosure programs can require substantial back taxes.
State tax nexus problems can create significant transaction hurdles, but proactive measures before selling your business can reduce or eliminate their impact. The optimal approach involves addressing these issues before buyer due diligence begins.
Nexus studies provide sellers tremendous advantages. By conducting comprehensive multi-state reviews before marketing a business, sellers maintain control over the remediation process and timeline. This proactive stance prevents the leverage shift that occurs when buyers discover issues during diligence.
Effective state tax due diligence requires specialized knowledge and tools that many internal teams lack. Outside advisors with resources and expertise across multiple jurisdictions can efficiently identify exposure areas that internal teams might miss. This specialized knowledge becomes particularly valuable when analyzing complex areas that frequently create surprise liabilities.
When nexus issues are identified, voluntary disclosure agreements (VDAs) may offer controlled remediation paths. These programs typically reduce penalties and limit lookback periods, substantially decreasing overall exposure. However, VDAs require careful navigation, as registration in a state without proper planning can eliminate program eligibility and expand liability.
For transactions already underway, transparent disclosure and remediation planning can mitigate negative impacts. Buyers may appreciate sellers who proactively identify and address compliance gaps rather than leaving them to be discovered during diligence. This transparency can preserve trust and negotiating position even when issues exist.
State tax nexus issues can create significant challenges in M&A transactions, with taxation of the digital economy and expansion of nexus standards increasing compliance complexity. For both buyers and sellers, addressing these issues proactively represents an effective strategy for preserving transaction value and terms.
Sapowith Tax Advisory helps middle-market businesses prepare for successful exits by identifying and resolving multi-state tax exposures before they become deal-breakers. From nexus and taxability studies to voluntary disclosure agreements to sell-side diligence & transaction planning, we provide the expertise and insight needed to protect enterprise value.
If you’re preparing to sell—or evaluating a potential acquisition—contact Sapowith Tax Advisory today to schedule a nexus review. One conversation now could save millions at the closing table.