Guest Author: Gary Bingel, Tax Partner, EisnerAmper
State and local tax nexus issues are often overlooked until a sale or audit exposes costly risks. For business sellers, misunderstood nexus rules can delay closings, increase escrow holdbacks, and create personal liability. In this article, Gary Bingel, Partner-in-Charge of EisnerAmper’s National State and Local Tax Group, explains why nexus matters—and how proactive analysis can reduce risk and uncover opportunities before a transaction.
Understanding the complexities of state and local taxes is challenging and requires patience and attention to detail. Consequently, many entities fail to fully analyze the nexus impacts of their operations, exposing them to non-filing risks that often surface at inopportune times: during a state audit or a potential buyer’s due diligence review.
While this aversion to potential negative outcomes is not uncommon, it can be short-sighted. From a seller’s standpoint, a lack of understanding of an entity’s nexus footprint can have several adverse consequences.
What Is Nexus and Why Does It Matter?
Nexus refers to the point at which an entity’s contacts with a state are sufficient to create various filing obligations. In general, when a business has nexus with a state, the state can assert jurisdiction. Once nexus is created, an entity must properly register with the state and is subject to numerous tax filings, including state and/or local income taxes, franchise taxes, sales taxes, and payroll taxes.
Creating Nexus: Still Misunderstood
How an entity creates nexus remains widely misunderstood. Many businesses mistakenly believe that nexus only arises from a brick-and-mortar presence. In reality, nexus can be triggered in various ways, and the activities that create nexus can differ not only by state but also by tax type within the same state.
Historically, nexus was created by having a physical presence in a state, such as having in-state property or employees on payroll, even if temporary or transitory in nature. However, “physical” presence could also be deemed to exist via the use of intangibles — like patents or trademarks — in a state. For income tax purposes, the mere presence of intangibles has been sufficient to create nexus since the 1990s.
In the 2018 Wayfair decision, the U.S. Supreme Court ruled that nexus can be established through economic contacts with a state, as evidenced by meeting certain sales thresholds (“economic nexus”). It is important to note that economic nexus provisions are in addition to other nexus provisions; they did not replace historic nexus theories, but supplemented them.
Since this ruling, every state with a general state sales tax has implemented some economic nexus provision for sales tax purposes. Many states have also implemented bright-line economic nexus provisions for income/franchise tax and gross receipts tax purposes.
So Why Should You, as a Seller, Be Concerned?
There are several reasons why business owners who are selling their company should be concerned about getting nexus right.
First, a nexus analysis is one of the first things a buyer will ask for during a due diligence process. If the buyer is not satisfied that nexus has been properly addressed, they will usually do their own analysis, generally taking a “worst case” viewpoint. This results in large sums being withheld in escrow. While you may think this is just a timing difference, buyers often use these funds to remediate any perceived exposure, rarely leaving anything left over to be released to the seller at the end of the escrow period. At best, even if you can successfully dispute the buyer’s analysis, this is often costly, stressful, and can result in delays in closing.
Another important concern for a seller is the risk of being held personally liable as a responsible party. Most, if not all, states have some sort of “responsible party” provision, under which individuals can be held personally liable for the outstanding tax liabilities of the company they owned and managed. Thus, if a company is found to have an unknown sales tax liability in a state due to having nexus, and failing to properly collect and remit sales taxes, personal liability may result. This usually impacts people overseeing the finances of the company and in a decision-making role.
Finally, when it comes to issues such as the right to apportion and throwback, nexus can even be advantageous at times. For example, establishing nexus in a low-tax-rate state with a high number of sales can minimize throwback to a high-tax-rate state, lowering the overall state tax liability. Likewise, creating the right to apportion income out of a high-tax-rate state into multiple lower tax rate states can also lower a company’s overall state tax liability. If the contemplated transaction is a stock sale, the buyers may be able to file refund claims for prior years for any tax amounts that were overpaid. Why would you want to give free money to your company’s buyer?
How Can EisnerAmper Help Reduce Risk and Identify Opportunities?
We take a holistic, risk-based approach to nexus studies. As every business situation is different, our multi-phased approach provides flexibility and allows us to tailor procedures to each client.
Phase 1 – Nexus Overview
We review a company’s facts and footprint and compare them to each state’s nexus provisions to determine whether each state represents a high, medium, or low risk.
Phase 2 – Taxability Review/Revenue Sourcing Review
Based on the results of Phase 1 and the client’s specific needs, we determine the proper sales tax treatment and/or sales factor apportionment sourcing of the client’s revenue streams. At the conclusion of this phase, we also perform a high-level exposure analysis.
Phase 3 – Remediation
Based on the results of Phases 1 and 2, we assist the client in determining the appropriate form of remediation, including back-filing returns and Voluntary Disclosure Agreements, as needed. We guide the client through each step of the remediation process so that prior period exposure is addressed efficiently and effectively.
Phase 4 – Ongoing Compliance
If needed, we can meet the prospective sales tax and/or income tax compliance needs.
This approach provides flexibility to customize our procedures to fit our clients’ needs, both technical and budgetary. It also offers set check-in points throughout the entire process, increasing communication and avoiding surprises.
Getting Started
Executive teams have a fiduciary responsibility to identify and manage nexus-related tax obligations. Nexus compliance can involve a combination of internal and external resources as the varying nexus rules can be complex and continue to change. Further, as an entity’s goals and/or customers change, unexpected nexus consequences may arise.
Executing an informed nexus strategy requires diligence but can be rewarding as entities better manage risks and identify opportunities through the process.
Do you need help assessing nexus in your entity?
Contact:
Gary Bingel, Tax Partner, EisnerAmper
