Crowe Horwath: Beyond income tax

Jon Cesaretti

During due diligence, what are some material state and local issues that private equity investment professionals might not be aware of or focus on?

We find that although many companies comply with state income tax reporting requirements, many miss local jurisdiction taxes, such as in New York City or Los Angeles.

Additionally, sales and use taxes, which often are overlooked, can create an unexpected and substantial past-due liability. And unclaimed property compliance almost always is neglected, to the point where management may not be aware that a reporting obligation even exists.

What approaches for remediating or addressing these issues would you recommend to fund managers in contemplation of closing?

Most state and local tax jurisdictions have programs where a taxpayer can voluntarily pay back taxes in exchange for an abatement of penalties and, in certain cases, interest. The most significant benefit of these types of programs is that the taxing jurisdictions often will limit the look-back period of liability from three to six years.

This is no small point, because generally there is no statute of limitations unless the taxpayer has a history of filing tax returns in a jurisdiction. Many times, buyers will mandate a voluntary disclosure and payment process be undertaken as a condition of close with appropriate escrows backstopping the liability that may be due.

After the deal is closed, how should private equity fund and portfolio managers remain tax compliant during ownership, especially when so many investments cross state lines?

We recommend allocating the tax compliance budget and process oversight based on an assessment of financial risk as relating to state and local taxes. For example, a company may have focused on state and local income tax compliance, even though income tax may not represent a significant risk if the company has been marginally profitable or has net operating losses.

However, the same company may have sales on a multijurisdictional basis that are subject to sales tax. If a company fails to collect sales tax from its customers, the uncollected tax almost always becomes the obligation of the selling company. The same point can be made for personal property tax and payroll taxes for a company that owns or rents property or has employees located in a number of states and localities.

What are the opportunities to minimize tax liabilities at the state and local level when structuring the exit?

On exit, the fundamental form of the transaction – sale of assets or stock – often dictates the state and local tax planning opportunities available to the seller. And the rules with respect to how gains (and losses) are reported can vary significantly from state to state.

Also, reviewing unique tax rules in each significant state in which the company operates may in aggregate result in tax minimization. Texas, for example, adopts unique rules that assign taxable gain related to the sale of intangibles to the location of the buyer’s legal domicile (state of incorporation).

These rules, if the transaction is structured correctly, can provide significant savings should the buyer of such a business be located outside of Texas. It should be noted that this complexity also can create a risk of double taxation, which is why state and local tax specialists should carefully analyze all deals.

This article is sponsored by Crowe Horwath. It was published in a supplement with the October issue of pfm magazine.