Prior to selling, companies should identify the risks they face related to state and local taxes. The first phase in this process is defining the scope of material risk. For some companies, having $10,000 of past exposure is material, but for others this amount might be $100,000. Understanding the company’s materiality level ultimately helps guide the decision process once risk is identified. Given the impact it could have on the earnings multiple of a deal, it is important to define and understand materiality. The second phase in this process is analyzing specific areas of exposure. The risk assessment starts with cataloging the company’s activities and their locations. Questions should include (and often mirror state nexus questionnaires): • What is the nature of the target’s product or service? • Is the company an industry with special state and local tax concerns such as financial services, franchising and regulated transportation? • Where does the company have employees? • What are the employees doing outside the company’s home state? • Where does the company own or lease property outside its home state? • Where does the company maintain inventory? • Does the company render repair, maintenance or installation services through employees or subcontractors? • Does the business sell or license intangible assets such as software or patents? The company’s tax adviser can provide advice as to whether the company has risk in certain states and localities and special industries.

Additionally, the company’s tax adviser might perform a nexus study, tax procedures review or reverse audit to get an understanding of the business’s overall state and local tax exposure. The last phase in the process is developing ways to mitigate the company’s risk. After the initial exposures are found and they are determined to be material, it might warrant entering into a voluntary disclosure agreement or amnesty program with select states and localities. 18 On Balance Voluntary disclosure and amnesty programs are offered by states to encourage taxpayers, often anonymously, to file prior year returns and pay the related taxes. Most states will limit the prior filings to a look-back period, ranging from three to six years (or higher depending on the state).

The state will also waive any penalties associated with the taxes due. Voluntary disclosure agreements are often executed by potential sellers of a business in order to “clean up” its balance sheet. The removal of ASC 740 or ASC 450 tax liabilities prior to or as part of due diligence can lead to smoother negotiations with interested buyers. Pre-sale state and local tax due diligence by a seller might only lead to the recognition of unrecorded tax exposures if the proposed sale falls through. However, the process helps in setting a realistic selling price and the drafting of appropriate buy-sell warranty provisions. Again, the final result will likely be better for the seller and the buyer. The state and local tax due diligence investigation should not be the end of the process for the target. Leveraging off the findings, the new owners and management of the company should develop appropriate state and local tax compliance procedures, including an annual nexus review for the various types of tax.

They can be carried out as a part of year-end planning for the company. It should document its state and local tax compliance systems in the same way that other internal controls are documents as part of a financial audit. CONCLUSION If you are contemplating buying or selling a company, it is important to understand the company’s state and local tax exposure. Given the impact on deal multiples, coupled with an ever-increasing difficult compliance environment, buyers and sellers need to be aware of the possible existence of unrecorded liabilities.

Advance planning can go a long way toward a successful outcome for both sides of the deal. Jon P. Skavlem, CPA is a director in the State and Local Tax Group at Baker Tilly Virchow Krause, LLP in Milwaukee. Contact him at 414-777-5333 or jon.skavlem@bakertilly.com. Phillip A.H.

Roemaat, J.D., CPA is a manager in the State and Local Tax Group at Baker Tilly Virchow Krause, LLP in Milwaukee. Contact him at 414-777-5445 or phillip.roemaat@bakertilly.com. January|February 2014 Reposted with permission from On Balance, the magazine of the Wisconsin Certified Public Accountants www.wicpa.org shutterstock.com RISK MITIGATION PRIOR TO SALE .