When business owners plan for a sale, most of the focus naturally lands on valuation, deal structure, and federal capital gains taxes. Yet in many transactions, state and local taxes are the most costly and disruptive surprises. These issues often surface late in due diligence, when leverage has shifted to the buyer, and timelines are tight.
Three areas drive most of this risk: nexus, revenue sourcing, and state withholding requirements. Each can quietly create liabilities that reduce purchase price, increase escrow demands, or delay closing. Addressing these issues well before going to market gives sellers control. Waiting until they appear in buyer diligence often means negotiating from a weakened position.
The way companies operate today rarely fits neatly within one state. Remote employees, online sales, third-party logistics providers, and digital services have expanded the geographic footprint of even small businesses. At the same time, states are enforcing compliance more aggressively as they compete for shrinking tax dollars.
For buyers, unresolved state tax exposure represents uncertainty. That uncertainty affects post-closing audit risk, operational continuity, and financial projections. For sellers, the impact is immediate and measurable. Buyers protect themselves by negotiating purchase price reductions, escrow holdbacks, extended indemnification periods, and, in some cases, by walking away altogether.
State tax issues do not derail deals because they are large. They derail deals by raising unanswered questions at the worst possible time.
Nexus determines whether a business has a legal obligation to file tax returns and collect tax in a given state. In the past, this required a physical presence such as an office, warehouse, or storefront. That standard shifted dramatically after the Supreme Court’s South Dakota vs. Wayfair decision, which allowed states to impose economic nexus based solely on sales activity.
Today, nexus can be created by a wide range of ordinary business operations. A single remote employee working from home, a contractor performing services, inventory stored in a third-party warehouse, or online sales exceeding economic thresholds can all trigger filing requirements. Many owners establish nexus without realizing it because nothing about daily operations feels different.
Once nexus exists, states expect full compliance. That includes registration, income or franchise tax filings, payroll compliance, and, often, sales tax collection and remittance. If filings are never made, buyers may assume multi-year exposure exists even if no audit has begun. The longer the gap between when nexus began and when it is discovered, the more cautious buyers become.
Even when nexus is identified correctly, many businesses stumble on revenue sourcing. Sourcing rules determine which state has the right to tax income, and they vary widely depending on the type of revenue and the nature of the business.
Service firms, software companies, and subscription-based businesses are especially vulnerable because states do not all apply the same sourcing methodology. Some tax income is based on where the work is performed. Others tax based on where the customer receives the benefit. Multi-state operations must also apply complex apportionment formulas that differ by jurisdiction.
When sourcing rules are applied inconsistently across years or across states, buyers may conclude that income was taxed in the wrong places. Even if the total tax paid was close to accurate, misallocation introduces audit risk and undermines confidence in the seller’s financial controls. During diligence, credibility matters almost as much as the dollars involved.
In many states, a business sale triggers withholding requirements at closing, particularly when the seller is a nonresident or real estate is part of the transaction. These rules require the buyer to withhold a portion of the purchase price and remit it directly to the state as a prepayment of the seller’s capital-gains tax.
From the buyer’s perspective, failure to comply creates direct liability. As a result, buyers often insist on withholding even when exemptions might apply. When sellers are not prepared for this, they can be surprised by restricted access to proceeds at closing. When handled late, withholding often becomes a point of tension precisely when both sides want the deal to move smoothly.
State tax issues rarely announce themselves clearly. They usually emerge indirectly during buyer diligence. A payroll review may reveal employees located in states where no filings exist. Logistics records may show inventory stored across multiple jurisdictions. Customer lists may indicate large revenue concentrations in states where the business was never registered.
Once these inconsistencies appear, buyers begin reconstructing historical exposure. Even when the seller believes the risk is minimal, buyers respond conservatively because they are inheriting the uncertainty.
Although the fact patterns vary by industry, specific exposure patterns appear consistently across transactions:
None of these issues are unusual. Deal risk arises when it appears unexpectedly and remains unresolved late in the process. Buyers interpret this not just as tax exposure, but as a breakdown in financial oversight.
When state tax exposure surfaces after a letter of intent is signed, buyers rarely treat it as a minor issue. They may demand purchase price reductions to offset estimated liability. They may require that a specific escrow be created solely for state tax risk. They may extend indemnification survival periods well beyond standard terms. In some cases, they delay closing while voluntary disclosures or amended filings are negotiated.
Even when the seller disagrees with the buyer’s risk estimate, leverage has already shifted. The buyer is no longer pricing the business as clean. They are pricing uncertainty.
The most effective way to protect value is to identify and resolve state tax issues before the company ever goes to market. This typically begins with a formal SALT nexus study, which determines where filing obligations exist and which taxes are implicated.
Once exposure is identified, voluntary disclosure agreements often provide a path to clean compliance. These programs frequently limit lookback periods, waive penalties, and reduce interest. When completed before marketing the business, they remove one of the strongest objections buyers raise during diligence.
Cleaning up historical filings is equally essential. Filing missing returns, amending inaccurate ones, and aligning sourcing methods across states transforms state tax risk from speculative to documented and controlled. Once resolved, these matters become background items instead of deal drivers.
Withholding requirements should also be addressed early. Knowing where withholding applies allows sellers to prepare exemption applications (if available), plan liquidity needs, and avoid surprises at closing.
Buyers fear uncertainty more than known exposure. A seller who can demonstrate that state tax risk has been reviewed, quantified, and addressed immediately changes the tone of negotiations. Escrow demands often shrink. Indemnification provisions narrow. Closing timelines stabilize.
State tax readiness directly affects valuation confidence. When buyers believe that compliance risk is under control, they are far more willing to apply higher multiples and proceed without heavy price protection.
Because state tax exposure spans multiple disciplines, it should never be handled in isolation. A coordinated team should include a CPA with SALT expertise, a transactional attorney, and a financial advisor who models after-tax proceeds. Payroll and logistics advisors may also play a role depending on the business footprint. This coordination ensures that compliance corrections align with deal structure and cash-flow planning.
State tax traps derail deals not because they are always enormous in dollar value, but because they inject uncertainty at the exact moment buyers want certainty. Nexus exposure, incorrect revenue sourcing, and unplanned withholding requirements all raise questions about risk and credibility, just as closing approaches.
By identifying and addressing these issues well before going to market, sellers protect valuation, shorten diligence timelines, and eliminate one of the most common sources of last-minute deal friction. In a well-prepared transaction, state taxes should be a known quantity, not a lurking threat.