Key Takeaways:
- Buyers will scrutinize tax compliance during the due diligence process.
- Failing to address potential underpayments or nexus issues can lead to purchase price adjustments, indemnifications, or even deal cancellations.
- A proactive tax nexus analysis can spot potential issues early and protect your business valuation.
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Preparing a manufacturing business for sale is a complex process. It can be so complex that around 10% of all announced transactions are canceled, according to an analysis from McKinsey.
When preparing your manufacturing business for sale, one way to help the deal go through is to conduct a tax nexus exercise. This process identifies your business’s income and sales tax obligations and addresses potential underpayments before a buyer performs due diligence. Taking a proactive approach to state and local tax exposures can be the difference between a seamless sale and a derailed deal.
Understanding Nexus in the Manufacturing Industry
Nexus refers to the connection between your business and a state that obligates you to collect and remit sales tax or pay income taxes. You can create nexus through physical presence (such as employees, offices, or warehouses in a state) or economic activity (based on thresholds like sales volume or number of transactions).
The landscape of sales tax nexus has grown increasingly complex since the 2018 Supreme Court decision in South Dakota v. Wayfair, which expanded states’ authority to enforce economic nexus laws for sales tax collection.
Why Nexus Matters in a Sale
Buyers who evaluate a business scrutinize tax compliance as part of the due diligence process. If a manufacturer has failed to address nexus obligations, the buyer may:
- Adjust the purchase price to account for potential tax liabilities.
- Hold back funds in escrow until you resolve the exposure.
- Demand indemnification, placing the financial burden of future tax disputes on the seller.
Common Pitfalls for Manufacturers
Manufacturers face unique challenges in managing tax compliance. Below are some common pitfalls and tips for avoiding them:
Failing to Collect Resale Certificates
Many manufacturers sell at wholesale and rely on resale certificates to exempt transactions from sales tax. However, failing to keep certificates current or collect them from all customers can lead to significant exposure.
For example, one of our clients, a manufacturer of high-end doors, unknowingly triggered nexus in multiple states through their installation activities. When the business was up for sale, buyers uncovered an estimated $5 million in uncollected sales taxes.
Fortunately, after analyzing their prior accountant’s workpapers, we realized the manufacturer had not collected resale certificates from many of their customers. By collecting those certificates, we reduced the estimated liability to $300,000, salvaging the deal without significant price adjustments.
Underestimating Economic Nexus Thresholds
States vary widely in their economic nexus thresholds, with some as low as $100,000 in sales. Manufacturers with high transaction volumes or multi-state operations may unknowingly exceed these limits.
For this reason, you must have mechanisms in place to monitor sales volume in each state where you make sales. Many states have a short turnaround time in which they expect you to register once you exceed the economic threshold.
Overlooking Corporate Employee Activity
Having employees work in a state, even temporarily, can create nexus. For example, employees working remotely from another state or sending clients across state lines for installations or inspections may trigger physical nexus.
Determine where all employees, especially remote workers, live and work to assess potential nexus implications.
Assuming Public Law 86-272 Provides Protection
Historically, manufacturers relied on Public Law 86-272, which exempted businesses from income tax if their activities were limited to soliciting orders for tangible personal property shipped from outside the state.
In 2021, the Multistate Tax Commission, an intergovernmental agency dedicated to ensuring fair and consistent tax policy among states and localities, updated its interpretation of PL 86-272, concluding that most internet-based sales fall outside its protections.
If your business relies on PL 86-272 to shield transactions from state income taxes, it’s crucial to analyze what specific economic, physical, or digital activities occur in each state and address them before putting the business up for sale.
How MGO Can Help
If you are preparing to sell your business, conducting a tax nexus exercise isn’t just “nice to have” — it’s an essential part of preparing the business for sale.
Considering nexus compliance upfront protects the business’s valuation, streamlines the sale process, and addresses financial risks for both seller and buyer. If your current accounting firm lacks this capability, ask them to team up with a firm that has a state and local tax-focused niche.
Proactively addressing state tax compliance with the help of an experienced team like MGO’s State and Local Tax group can help your deal close smoothly and profitably.