October 3, 2025
Mergers and acquisitions (M&A) present numerous opportunities—but also complex state tax considerations that can significantly affect transaction outcomes. M&A’s are powerful techniques for growth, transformation, and strategic realignment. But beneath the surface of deal terms and valuations lies a complex web of state tax considerations that can significantly impact the success of a transaction. Buyers and sellers need to consider factors such as successor and personal liability, state agency information sharing, and increased audits—especially around state income and sales taxes. Whether you’re buying or selling a business, understanding these tax implications is essential to avoid costly surprises and ensure compliance.
A proactive seller will conduct internal due diligence to identify and analyze the risk associated with any potential non-compliance, positions taken on income/franchise, or sales/use tax returns. Doing this work prior to soliciting acquisition offers means the seller can control the process and mitigate risk on their own timeline.
A purchaser should always perform due diligence around state and local tax items to identify risk prior to the acquisition, where this risk and potential liability may transfer to the purchaser.
Since the outcome of the state tax due diligence may affect negotiations or decisions to proceed with a transaction, getting the proper team involved is a wise investment, regardless of which side of the table one is on.
To get you started on the path toward a successful deal, we’ve outlined areas that buyers and sellers should analyze for potential risk in M&A transactions.
Income/Franchise Tax Considerations:
Nexus and Apportionment
State income tax liability begins with nexus, a business’s connection to a state that triggers tax obligations. Nexus can arise from physical presence, economic activity, agency relationships, or even digital operations. Buyers must assess whether the target company has nexus in states where it may not be filing returns. If the target is a seller of tangible goods, a key question is whether the business is protected from income tax under Public Law 86-272. This law, also known as the Interstate Income Act of 1959, protects certain businesses from state income taxes under specific circumstances.
State taxing authorities and changing business practices, particularly the rise of e-commerce, have gradually narrowed or weakened the protections the law offers to businesses. If you have not reviewed your activities in light of the most recent P.L. 86-272 developments, you may not have the protection you thought you had.
Once nexus is established, apportionment rules determine how much income is taxed by each state. These rules vary widely, and differences in sourcing methods (market-based vs. cost-of-performance) can lead to unexpected tax burdens post-acquisition. These two general sourcing methods are highly nuanced, and the definitions and calculations vary state by state.
Allocation of Gain from the Transaction
The allocation of gain from the sale of a business interest, especially in partnerships, S corporations, and LLCs, raises the question of how the gain is treated by the partner/shareholder/member. Gains from the sale of intangible assets (like partnership interests) may be treated as business income and thus apportioned and taxed based on the entity’s activities in the various states.
Alternatively, depending on the circumstances, the gain may be considered nonbusiness income and thus allocated to a single state. And if the seller is an individual or group of individuals, the determination of where the gain is taxable is based on an entirely different set of rules.
Tax Attributes and Elections
Buyers often seek to leverage the target’s net operating losses (NOLs) and tax credits, but these benefits may be limited (or lost entirely) depending on the transaction structure. Section 382 limitations, invalid S-corporation elections, or improper federal and state filings can all affect state-level outcomes.
Entity Type and Risk Allocation
The legal structure of the target (C-corporation, S-corporation, partnership, or LLC) affects who bears the tax risk. For example, pass-through entities may shift income tax burdens to individual owners, while C-corporations generally retain these liabilities. Understanding this dynamic is critical for deal pricing and structuring.
Sales/Use Tax Considerations:
Successor Liability
Sales tax liabilities often follow the business, even in asset sales. Many states impose successor liability, meaning the buyer may inherit unpaid sales taxes regardless of the transaction type. Due diligence should uncover unaccrued liabilities, missing exemption certificates, or compliance gaps.
Bulk Sale Rules and Notifications
Some states require bulk sale notifications to avoid inheriting the seller’s tax debts. Failure to comply can result in escrow requirements or delayed closings, as well as future liabilities for the buyer.
Buyers should consider obtaining tax clearance certificates to mitigate exposure.
Sales Tax Nexus and Taxability
With permission from the US Supreme Court in the Wayfair decision, all states now have an economic nexus threshold for sales tax collection based on revenue (and in some cases on unit sales). Buyers must evaluate whether the target has collected and remitted taxes correctly across all applicable states and localities. Physical presence and affiliate or agency relationships are still nexus-creating activities. For example, “affiliate programs” (where a content creator, magazine, or other organization posts links on their websites to online retailers and receives a commission when purchases are made through those connections) can create sales tax collection obligations for the seller.
Changing Legislation and Audit Risk
States frequently revise their sales tax laws to keep pace with technology and/or to broaden their tax base, especially in areas like cloud computing, digital advertising, and IT consulting. These changes can retroactively impact liability and increase audit risk. Buyers should evaluate whether the target’s systems can adapt to evolving rules.
Due Diligence Best Practices
We recommend that buyers and sellers take these strategic actions.
- Conduct Nexus Studies: Identify where the target has filing obligations and whether it has complied.
- Review Federal Tax Returns: Errors in federal filings often cascade into state issues.
- Evaluate Tax Systems: Ensure the target has robust systems for tracking, collecting, and remitting state and local taxes.
- Mitigate any Exposure: Once identified, clarify what risk mitigation strategies are available and follow through. Voluntary Disclosure/Amnesty Programs are designed for non-compliant businesses to become compliant. Under these programs, the taxpayer submits delinquent returns and tax payments for a specified period of time, typically, shorter than what the state could otherwise require. In exchange, non-filing or late payment penalties are often waived.
State tax issues in M&A are complex and often underestimated. With over 12,000 sales tax jurisdictions in the U.S. and over a dozen states allowing cities, counties, and municipalities to impose their own income taxes, even the total number of tax jurisdictions is difficult to estimate. Suffice it to say, compliance with all jurisdictions is complex and takes substantial resources. Whether evaluating income tax nexus or uncovering hidden sales tax liabilities, thorough due diligence and strategic planning are essential. Buyers and sellers must navigate these challenges precisely to protect value and ensure compliance. By addressing state tax considerations in mergers and acquisitions early, both buyers and sellers can protect deal value and ensure compliance.
For more information and assistance in navigating the tax complexities of mergers and acquisitions, visit our M&A services page and connect with a Clark Nuber team member.
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