Target Company Red Flags: SALT Exposure, Worker Classification, and Nexus

Every seller believes their business is fundamentally sound; buyers approach acquisitions assuming the opposite. They do this not out of cynicism, but out of experience. Over time, specific tax-related issues have proven so disruptive that buyers treat them as immediate red flags. When discovered late, these issues can slow a deal, reduce valuation, or halt negotiations entirely.

Three problem areas consistently rise to the top: state and local tax (SALT) exposure, worker classification, and unregistered nexus. None of these issues is unusual, especially for growing businesses. What matters is whether they are identified and addressed by the seller before the buyer.

This article explains why these red flags concern buyers, how they typically surface during diligence, and what sellers can do to resolve them in advance.

Why Tax Red Flags Carry Outsized Weight

In an acquisition, buyers are not just purchasing historical performance. They are also acquiring future risk. Tax red flags matter because they introduce uncertainty that extends beyond the closing date. Unlike operational issues that can be remedied after the sale, tax liabilities often follow the entity and can trigger audits, penalties, and cash outflows years later.

Buyers respond to this uncertainty in predictable ways. They demand escrows, broaden indemnification provisions, extend survival periods, or adjust purchase price assumptions. In competitive processes, they may simply walk away and pursue a cleaner target.

The key distinction is not whether a company has issues. It is whether those issues are known, quantified, and resolved.

SALT Exposure: The Silent Deal Killer

SALT exposure is one of the most common and least understood deal risks. Businesses often operate across state lines long before they recognize the compliance obligations that follow. Over time, unfiled returns, unpaid taxes, and inconsistent sourcing practices quietly accumulate.

Buyers pay close attention to SALT because state taxing authorities are aggressive, audit cycles are long, and exposure can span multiple jurisdictions simultaneously. Even small annual amounts can become significant when penalties and interest accrue over several years.

SALT issues frequently surface during diligence through indirect evidence. Payroll records may show employees in states where the company never filed. Sales reports may reveal revenue concentrations in states where no registration exists. Logistics data may indicate that inventory is stored in fulfillment centers nationwide. When buyers see these inconsistencies, they assume the worst.

Importantly, SALT exposure does not need to be high to be problematic. What concerns buyers most is the lack of clarity. Undefined risk is far more damaging than documented exposure with a remediation plan.

Worker Classification: A Layered Liability

Misclassification of workers is another issue that can quickly alarm buyers. Treating workers as independent contractors rather than employees may reduce costs in the short term, but it creates layered exposure that extends well beyond income tax.

Buyers evaluate worker classification carefully because misclassification can trigger back payroll taxes, penalties, interest, and potential wage-and-hour claims. In some cases, benefits eligibility and employment law violations also come into play. These risks are difficult to cap and often survive closing.

Classification issues typically surface when buyers review payroll records, contractor agreements, and job descriptions. If contractors perform core business functions, work under company direction, or operate exclusively for the business, buyers may conclude that reclassification is required. Even when the seller believes classification decisions were reasonable, the lack of documentation or inconsistent practices can raise red flags.

Because these issues affect both tax and legal exposure, buyers treat them as a high priority and often insist on significant deal protections if they remain unresolved. 

Nexus: Exposure You Didn’t Know You Created

Nexus determines whether a business has an obligation to file tax returns and collect tax in a state. Many sellers assume nexus only exists where they have offices or facilities. In reality, modern nexus rules are far broader.

Remote employees, contractors, inventory stored in third-party warehouses, trade show activity, and economic thresholds tied to sales volume can all create nexus. In many cases, nexus arises unintentionally as businesses grow or adapt to remote work environments.

Buyers routinely map nexus during diligence by comparing operational data to the filing history. When they identify states where nexus likely exists but no filings were made, they assume unreported exposure. Even if the business never received a notice from a state, buyers treat the obligation as real.

Nexus issues often overlap with SALT exposure, but buyers view them as a distinct red flag because they signal ongoing compliance failures.

How These Red Flags Typically Emerge

Rarely does a seller volunteer that they may have SALT exposure, misclassified workers, or unregistered nexus. Instead, these issues surface as buyers connect data points across different diligence streams.

A remote employee appears in payroll records. Sales reports show activity in multiple states. Contractor payments look indistinguishable from wages. Inventory records show fulfillment locations the seller never considered. Each discovery on its own may seem minor. Together, they create a pattern that buyers interpret as systemic risk.

When this pattern emerges, the conversation changes. Buyers stop focusing on growth and shift toward protection.

Why Late Discovery Is So Costly

When red flags surface late, sellers lose leverage. Buyers have already invested time and resources, but they are no longer pricing a clean business. They are pricing uncertainty. At that stage, even well-intentioned sellers struggle to push back against escrow demands or price adjustments.

By contrast, sellers who identify and address these issues early control the narrative. They can explain what existed, what was fixed, and why the remaining risk is limited. Buyers respond very differently to resolved issues than to surprises.

A Targeted Checklist for Sellers

Before going to market, sellers should conduct a focused internal review to identify whether these red flags exist. The goal is not perfection, but awareness and remediation.

A practical pre-sale review should confirm:

• Whether employees or contractors are located in states where no tax filings have been made
  
  
• Whether worker classification decisions are documented and supported by job function and control factors
• Whether sales activity, inventory storage, or contractors have created nexus in additional states
• Whether state income, sales, and payroll tax filings align with operational reality
• Whether voluntary disclosure or corrective filings are needed to limit historical exposure

Completing this review with experienced advisors transforms these issues from deal breakers into manageable disclosures.

Fixing Issues Before Buyers Find Them

The most effective way to address tax red flags is through early remediation. For SALT exposure and nexus issues, voluntary disclosure programs often limit lookback periods and reduce penalties. For worker classification, reclassification and updated agreements can help prevent exposure from growing and demonstrate good-faith compliance.

Timing matters. Corrective actions taken before a sale are viewed far more favorably than promises to fix issues after closing. Buyers want evidence that problems were addressed when the seller still controlled the business.

Who Should Be Involved

Addressing these red flags requires coordination. A CPA with SALT experience can identify filing gaps and quantify exposure. An employment attorney can assess the risk of worker classification. Transaction advisors can model how unresolved issues affect deal terms and after-tax proceeds.

Handled together, these efforts prevent isolated fixes from creating new problems elsewhere in the deal.

Final Thoughts

SALT exposure, worker classification errors, and unregistered nexus do not scare buyers because they are rare. They scare buyers because they are common, difficult to unwind, and often discovered too late.

Sellers who proactively identify and address these issues enter the transaction with credibility and control. Instead of negotiating from a defensive posture, they present a business that understands its risks and has taken steps to manage them.

In an M&A process, avoiding red flags does not mean eliminating every issue. It means ensuring that nothing critical is discovered for the first time by someone else.