Summary: If you’re ever planning on selling your business, you can protect your business’s future valuation by collecting and remitting sales tax now. A messy sales tax picture can slow or even stall the sales process, or even result in a reduced valuation.
Entrepreneurs wear many hats: inventor, manager, bookkeeper, salesperson, researcher, leader. With so many tasks to keep track of, it’s not inconceivable that important things can sometimes fall through the cracks. However, for any business selling consumer products to end customers in the United States, one item you absolutely don’t want to let fall by the wayside is the collection and remittance of state sales tax. Improper or incomplete management of this function can not only become a financial and operational problem for any going concern, but when it comes to selling the equity or assets of a Company, it can become a roadblock to a successful transaction.
Prior to 2018, e-commerce companies typically only worried about collecting and remitting state sales tax if they owned property or paid employees in the given state. This shifted the burden to the consumer through use tax, creating something of a gray area in which companies could operate more freely without risking tax liability.
This all changed when South Dakota sued Wayfair for failing to remit sales tax the state felt it was owed.
The resulting U.S. Supreme Court ruling found that e-commerce businesses are responsible for collecting and remitting sales tax in any state where they are deemed to have nexus. Consequently, the economic nexus of e-commerce companies was forever altered – states began instituting and enforcing more stringent rules concerning sales tax, placing the burden squarely on the businesses.
There are two basic conditions under which an e-commerce business may be required to collect and remit sales tax in a given state:
1.) the company has a physical presence in the state or
2.) the company’s sales exceed a predetermined threshold.
The exact qualifications vary from state to state, which creates the opportunity for a messy, confusing tax picture. It’s far easier to collect sales tax from customers now than it is to pay the state later if a sales tax audit determines that a business should have been collecting sales tax. At that point it is virtually impossible to go back and collect the sales tax from customers for those past transactions, putting the financial burden of paying the tax squarely on the Company. This is why many companies hire a third-party service provider (like TaxValet!) to ensure the business follows all applicable rules and regulations in every state they sell products in.
Now more than ever, it’s important to stay on top of sales tax as part of your regular financial review. Inattentive business owners have found themselves in hot water after one or several states suddenly came calling after years of unfiled sales tax returns. But owing back taxes is just the beginning of the long-term potential consequences of neglecting to effectively manage sales taxes.
If the owners of a business are considering selling the Company, a messy tax picture can slow or even stall the process, or even result in a reduced valuation. During the acquisition due diligence process, an acquirer will conduct a thorough review of the company’s finances including all sales data and sales tax returns. If due diligence reveals that the Company has failed to properly collect and remit sales taxes across one or many states, that presents a potential liability for the party that purchases the business.
This is due to the fact that case law has shown that states can pierce through the transaction documents and bring action against the new owners of the business if the previously owed taxes are not recoverable from the prior ownership or entity. Therefore, a prospective acquirer may insist upon additional provisions in the deal terms if they discover the company has unresolved tax liability.
The severity of the prospective acquirer’s response to a potential sales tax liability depends on just how much liability exists. They may request that the estimated tax liability be withheld from the purchase price to remain in escrow until a set time has passed and the acquirer is satisfied they will not incur the tax liability of the Company’s previous owner. Alternatively, they may insist that the owner file all outstanding sales tax returns and pay any outstanding state sales tax debts (including interest and penalties) before the deal can proceed, effectively stopping the deal in its tracks.
A tax liability can also fundamentally alter the deal terms. For example, if you’re seeking $10 million dollars for your business but you have $1 million dollars in tax liability, a prospective acquirer may reduce their maximum offer by even more than the potential sales tax liability because they perceive an overall greater level of risk associated with the Company. It is also possible that the acquirer completely withdraws their interest in the deal.
Advanced preparation can help you avoid a myriad of problems, from complications at the state level to complex issues blocking your anticipated exit from your company. A professional Mergers and Acquisitions advisor, together with qualified tax professionals like TaxValet, can help you get your ship in order so you can plan for the future. Don’t wait until it’s too late, start thinking about your sales tax picture today!
Global Wired Advisors formed out of a desire to serve the burgeoning community of online and e-commerce businesses that make up an otherwise-overlooked segment of the lower middle market. With a wealth of knowledge and experience in building, growing, buying, and selling digitally native businesses at their disposal, our team of Mergers and Acquisitions experts is uniquely positioned to advise you throughout the process of selling your business. We are committed to achieving the best results for our clients and delivering a world-class service experience.